August 2, 2012

Equities: Is a bear market inevitable in this economy?

Posted in debt, Economic Growth, Economy, Europe, Finance, government, investment banking, investments, payroll tax reductions, recession, Stocks, Uncategorized, Unemployment tagged , , , , , , , , , , , , , , , , , at 7:40 PM by Robert Barone

All of the data and the trends in the data indicate that it is possible that a recession might already have begun.

• Job creation has been dismal in the second quarter, with little hope for improvement soon; jobless claims are, once again, on the rise.

• Retail sales have fallen three months in a row; this has never occurred without an ensuing recession. What is of greater concern is that this has occurred while gasoline prices have been falling.

• While market pundits have cheered small gains in housing data, it is clear that housing is still bottom bouncing. Changes in foreclosure laws have caused supply constraints that have made it appear that home prices are rising again.

• Industrial production, the one bright spot in the economy, showed a decline in May before recovering somewhat in June.

• The drought has caused raw food and commodity prices to spike. These will soon translate into higher food and raw input costs. (Is anyone now questioning the wisdom of the congressional mandate to produce increasing quantities of ethanol from corn instead of sugar?)

 • Consumer confidence continues at levels below those seen in past recessions . Much of this is due to uncertainty surrounding fiscal policy and taxes.

• In the June Philadelphia Fed Survey, manufacturers were asked to list reasons for slowing production; 52 percent cited uncertain tax policy and government regulations.

• Real incomes are falling. The downward bias in the inflation numbers produced by the government inflates the reported GDP numbers. It has been my view that, as a result of the biased reporting, the recession never really ended, and real GDP is much lower than reported.

 Equity market up for year

 Nevertheless, despite all of the poor data, the equity markets have held up. At 1,338 (the closing level on July 25), the S&P 500 is still 6.4 percent higher than it was at the beginning of the year. This is strange, given that every other major market in the world is down 20 percent and in bear market territory. Here are a couple of possible explanations:

• The equity markets used to be a leading indicator of the economy. Severe market corrections (20 percent or more) usually meant recession was either imminent or already here. But, with the advent of computerized trading, the market now appears to be more of a coincident indicator. In late 2007, when the last recession began, the market was only off 5 percent from its October peak.

• Europe: There is such financial chaos in Europe that a flight to the dollar is continuing. Because higher quality bond yields are so low, some of the funds have found their way into the U.S. equity markets, thus keeping them buoyed.

Neither of these two reasons should give investors any confidence that U.S. markets can hold up. Besides the poor internal economic data within the U.S., worldwide data have been weak. In addition to the obvious problems in Europe, China is in a much slower growth mode, as is Japan, the rest of Asia, and even the commodity producers like Australia and Canada.

European soap opera
Europe is a whole other issue. American markets have benefited from their financial issues, but when panic and contagion show up over there, markets behave poorly over here. We have seen this time and again as the European drama (really a soap opera) has unfolded. It would be far better for the European politicians to come up with an
orderly plan for countries to exit the monetary union than to deny that the union isn’t in any danger of falling apart.


Solvable “fiscal cliff”

Finally, the approaching “fiscal cliff” in the U.S. is another wild card that could have a significant impact on capital markets. The good thing about the “fiscal cliff” is that it isn’t an outside force being imposed. The cliff is avoidable and completely under the control of Congress and the president.

With all of this going on, is a bear market inevitable? While I think that the confluence of events (worldwide economic slowdown, slowdown in the U.S., European financial chaos, “fiscal cliff”) make it likely, as I indicated in my last column, the application of “business friendly” policies could prevent it.

Until visibility into policy becomes clearer, investors should continue to be extremely cautious. They should remain liquid.

 Finally, the U.S. economy is so fragile that any external shock, like a financial implosion in Europe, is certain to have negative impacts on U.S. markets. Policy responses to economic slowdown or financial chaos (e.g., printing of money by the European Central Bank or QE3 by the Fed) are likely to have a positive impact on the value of precious metals and commodities. And the ongoing drought will definitely move food and commodity prices upward.

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.

March 9, 2012

Wall Street gives Hayes the runaround

Posted in Banking, Big Banks, Business Friendly, community banks, Economy, Finance, government, investment advisor, investment banking, investments, local banks, Nevada, Stocks, Uncategorized tagged , , , , , , , , , , , at 4:08 PM by Robert Barone

The S&P 500 closed at 1,342 on Feb 10. It was at that level in May 2008, January 2001 and June 1999. For nearly 13 years, investors in America’s largest companies have essentially made little return on their investments.
But think about all the multi-millionaires and billionaires Wall Street has created f rom within its own ranks in that time span! It’s almost as if the game is rigged against the small investor.
Unfortunately, it is.
M.F. Global, for example, pledged and lost its clients’ assets in a bet on Italian bonds. Had the bet paid off, the firm and its management stood to benefit, not the clients. Yet the clients were on the hook when the bet went sour. In 2009, the government used taxpayer dollars to save the “Too Big To Fail” banks (which have since grown by more than 25 percent), or those in trouble because they had grossly over-levered their balance sheets. As if nothing had happened, in 2010 these institutions paid their management record bonuses ($1 million is chump change).
There is story after story in the investment world of small investors being bilked out of their hard-earned assets. It’s largely due
to a system that always puts the clients last. Here are some examples:
Outside Managers: Oftentimes, broker/dealers and/or supposed investment firms send client assets to outside managers. The client has to pay double fees – one set to the investment firm and another set to the outside manager. The outside managers often rebate part of their fees and expenses to the investment firm. Worse, the outside managers direct their discretionary purchases and sales, especially in bonds, back to the introducing firm’s trading desk. That desk, knowing full well there will be no competitive bid from other trading desks, adds a significant mark up or down from the true market price.
Shelf Space: In order to be available to clients, the large broker/dealers require smaller mutual funds to pay a monthly fee. In addition, all of the funds must rebate to the broker/dealer all or part of the 12b-1 fee that they charge as part of their expenses where these are split between the firm and the account rep.
In today’s world, there is absolutely no reason to pay a front end or back end “load” for a mutual fund. Yet many clients of the large broker/dealers pay loads as high as 5 percent, much of which is retained by the broker/dealer. If you are being charged a “load” when you buy mutual funds, ask yourself if your interests are being put first. Vanguard funds are widely known for having no loads (or 12b- 1 fees) and their expense ratios are among the lowest in the industry. Ask your account rep if you can buy Vanguard funds in your account. If the answer is no, consider whose interests are being put first.
Inappropriate Investments: This is really the biggest issue for small investors. Because of the cost of litigation, most small investors who have lost significant sums due to inappropriate investments cannot afford to fight a legal battle to recoup losses. Most of the time, inappropriate investments occur because the fee to the selling agent or institution is so significant that the clients’ best interests are put behind those of the firm or the account rep. A good practice is to ask your account rep the amount of commission associated with any particular trade.
The accompanying news story about Bobby Hayes of Incline Village, his local attorney, Thomas Bradley, and his broker/dealer Merrill Lynch (now Banc of America Securities) illustrates many of these points:
• In July 2007, Mr. Hayes told his account rep he didn’t want to take any risk with $883,122. His account rep put him into a high risk tranche of a collateralized mortgage obligation. If the value of the assets in the tranche fell by as little as 0.5 percent, Mr. Hayes’ investment would be wiped out. (During the last decade, Wall Street’s financial “rocket scientists” divided up the cash flows from mortgages such that some tranches were quite secure while others were quite risky. Guess which one Mr. Hayes got?) Did his account rep have any idea about the risk inherent in this investment? If the account rep did, he/she clearly violated his/her fiduciary duty to the client, as minimal due diligence (i.e., a call to the New York desk) would have uncovered the risk. Most likely, the account rep was blinded by the large ($37,000) fee associated with the sale of the tranche.
• As it turns out, the loans Merrill Lynch placed into the tranche had already fallen in value by 5 percent before the investment was sold to Mr. Hayes. The investment was worthless at inception. Worse, it looks like the folks at Merrill Lynch who issued the paper knew it.
• After more than five years, arbitrators awarded Mr. Hayes $218,000 in attorney fees. In addition, Hayes had to shell out $23,500 in other costs and was potentially liable for $8,400 in hearing fees.
• Hayes won the return of his investment, interest on it, attorney fees and the other costs, or about $1.38 million, because it was clear, even to the arbitrators, that the paper sold to him was worthless before it was purchased on his behalf and that Merrill Lynch most likely knew it. Yet despite the apparent fraud and Merrill Lynch’s shunning of its fiduciary duties to the client, no punitive damages were awarded. This speaks to the inherent bias against the investor and for the broker/dealer, which appears to permeate the system when it comes to Wall Street.
• It is interesting to note there were two such tranches, one for U.S. clients and another for foreign clients. Mr. Hayes purchased the entire U.S. tranche. The foreign investors, who purchased the other tranche, also sued and settled for an undisclosed amount. Of further interest in this case is that the Massachusetts Secretary of State has subpoenaed the same or similar records to see if Merrill Lynch knowingly overvalued assets it put into investment pools (“Galvin demands B of A records on mortgages,” www. on Feb. 11).
• Mr. Hayes’ attorney, Reno’s Thomas Bradley, has written about other inappropriate investments being foisted on unsuspecting small investors, usually because the commissions on the sales of such instruments are high (see http://blog. mislead-by-brokerage-firms-to- purchase-unlisted-reits.html).
From a lack of any real return to unconscionable fees and costs to an unaffordable and often unjust litigation process, the Wall Street system is rigged against the small investor. Just think of how many small investors were put into similar investments by Wall Street’s major broker/dealers. Few of them have the assets or stamina to fight Wall Street like Mr. Hayes did.
Most, if they actually do pursue legal action, settle for pennies on the dollar because of the costs, effort, and additional potential loss should the arbitrators rule against them.
Despite these abuses, the government continues to come to Wall Street’s aid. No one yet has gone to prison over the sub- prime fiasco. No one is likely to go to prison in the M.F. Global scam. Despite the obvious fraud, no punitive damages were assessed in the Hayes case.
U.S. households have $700 billion in negative equity in their homes, and the government (who had its own fingers in the mortgage fiasco) last week settled with the biggest perpetrators for 3.5 cents on the dollar. With only slaps on the wrist and minor fines or penalties for fraudulent behavior and the shirking of fiduciary obligations, what will incent Wall Street to alter its behavior?
Conclusion: Little is going to change for small investors in America unless and until the Wall Street playing field is leveled.
Robert Barone, Ph.D.

February 22, 2012

Dr. Robert Barone Interview with Face the State on KTVN News Ch2

Posted in Banking, Big Banks, Business Friendly, Economy, Education, Finance, Foreclosure, Gaming, government, Housing Market, investment advisor, Las Vegas, Nevada, taxes, Unemployment tagged , , , , , , , , , , , , , , , , , , , , , , , , , , at 4:15 PM by Robert Barone

If you missed the televised interview with Robert Barone on February 16th, 2012 with Face the State on Ch.2 News, you can watch the video by clicking the link below.

Dr. Robert Barone Interview with Face the State on KTVN Ch. 2 News

November 9, 2011

Euro End Game: All Roads Lead to Monetary Breakup

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 6:39 PM by Robert Barone

— Three major issues must be resolved to save the European Monetary Union (EMU): The value of sovereign debt; the European bank capital issues; and the fiscal capacity or will to provide the needed financing. Unfortunately, no feasible solutions exist. The politicians have done everything they could to keep the market on the edge while, at the same time, continuing to kick the can down the road. The farther the can is kicked, the more painful and costly the ultimate resolution — the breakup of the EMU.

The Value of Sovereign Debt

As of this writing, the haircut on Greek sovereign debt currently on the table is 50%. The French want as small a discount as possible (it was originally set to 21% in the July agreement which was just ratified by the EMU countries a couple of weeks ago) because French banks hold volumes of Greek sovereign debt.

Germany, the other major player in the drama, wants a larger discount to force the private sector to contribute to the resolution, and because they know that they, and they alone, are the ultimate guarantor. The 50% haircut, however, is really not 50% because the EFSF and ECB, which hold 55% of all Greek debt, are exempt from the
haircut. So, at the max, Greece will be relieved of 22.5% of its debt.

However, in order to give Greece a half a chance to survive within the euro circle, the discount should be 80%, not 22.5%%. Even at an 80% discount, Greece’s Debt/GDP ratio will still be greater than 90%. At a 22.5% haircut, their Debt/GDP ratio will be so high, and interest payments to outside debt holders so onerous that it will require too much austerity. As we have just witnessed, Greece cannot meet the current required austerity measures imposed by outsiders. If the haircut on the Greek debt is too small and austerity is too severe, which it will be under the current set of principles being discussed, social unrest will continue. 

Ultimately, the Greek people will elect politicians who vow to remove the imposed austerity. The rise of Hitler was partly the result of imposed “reparations” from the previous war and the hyperinflation that resulted. If still inside the EMU, the problem of the value of the Greek sovereign debt re-emerges under the scenario now on the table. So, it is vital that the Greek debt haircut be large enough to give Greece at least a chance to succeed within the EMU. Of course, that assumes that there is a shift within Greece away from the entitlement mentality
that pervades the culture and that, given a second chance, they will adhere to a fiscal discipline. History indicates low odds of this.

But there are more issues that arise in the scenario in which Greece is given a second chance and kept inside the EMU. The slippery slope is that if the bond haircut is high, then Portugal, Ireland, Spain and Italy see that Greece has been given a second chance with much of its debt forgiven, they will want the same treatment. After
all, why should these countries institute austerity to pay the private sector and often foreign debt holders when Greece doesn’t have to.

In order to avoid the contagion that the others will want the same deal as Greece, there will have to be a consequence that dissuades them. The only consequence I can think of that is serious enough to dissuade them is expulsion from the EMU. Therefore, in order to avoid contagion under a scenario of an 80% bond haircut, it is
essential that Greece leave the monetary union, and that the EU set up and strictly enforce expulsion criteria.

Ultimately, though, because the four problem countries all have the same entitlement mentality, they will never be able to maintain the required fiscal discipline, and will ultimately be expelled. Apparently, the European politicians recognize this.  So, the 22.5% haircut deal currently on the table simply kicks the can further
down the road. The deal on the table cannot ultimately work.

European Bank Capital Issues

No matter how it is sliced or diced, Europe’s major banks are undercapitalized, and that is being kind. If
the sovereign debt they hold is marked to market, they are all insolvent. As we know from America’s S&L crisis in the ’80s and from the recent ’09 meltdown experience, a financial institution can operate in an insolvent condition for years, as long as it can get liquidity. In fact, there may still be such zombies in the U.S.

Enter the European Financial Stability Facility (EFSF). It’s function will be to support (i.e., buy) the underwater sovereign debt held on the books of Europe’s financial institutions at prices significantly above market, thus transferring the ultimate losses from the private sector to the taxpayer. The Fed did this in ’09, purchasing billions of mortgage-backed securities at above market prices from U.S. financial institutions. In effect, this is equivalent to the taxpayer making a capital contribution to the banks without receiving any ownership
interest. This is just a gift from taxpayers to stock and bond holders.

The ultimate capital contribution to the European banks will be in the trillion euro range, and it is likely that the EFSF will attempt to use leverage. But, because the capital contributions to the EFSF already being discussed (and I expect they aren’t as large as they need to be) are large relative to Europe’s GDP, there are likely to be ratings downgrades, causing interest costs to rise and making austerity in the EU even harder to bear. Under existing discussions, France, one of the two major characters in the whole crisis, is expected to make a contribution to the EFSF that is equal to 8% of its GDP. This alone will surely result in a ratings downgrade, as its Debt/GDP ratio has risen nearly 20 percentage points this year alone.

How long will the public endure the resulting austerity? Only long enough for the political process to elect leaders who promise to get rid of it. And, how do they do that? Exit the EMU.

Fiscal Capacity

It is clear that Germany and France are the key players (who are expected to be saviors) in this European drama. As explained above, as the drama unfolds, it is likely to put a tremendous strain on France’s fiscal capacity making it impossible for France to contribute further resources to the crisis (they are already on the hook for a significant contribution to resolve the Dexia issues). That leaves Germany as the last bastion of the euro. Think of the irony. The German people, by a large majority, never wanted to join the EMU. Their politicians brought them in kicking and screaming. Now, they are going to be asked to pay for all the entitlement and profligacy of their European neighbors. This just isn’t going to fly. When it gets to this point, and it will, Germany will simply say no, and that will be the end of the EMU.


It is already too late. The euro cannot be saved without the adoption of the U.S. federal model where the countries become the equivalent of U.S. states with one monetary and fiscal policy, ultimately run by Germany. Because of culture and history, the odds of this happening are about 0%.

The financial ministers can meet. There can be weekly, or even daily summits between the prime ministers. They can dream up debt Ponzi schemes with the EFSF, and can transfer losses from the private sector to the taxpayer. And, they are likely to do all of the above. But, ultimately, it is too late.

The EMU did not enforce its original rules, and now there is way too much debt. Like the S&Ls in the U.S. in the ’80s, it can be propped up for awhile. But, all of the actions that add debt or transfer it from the private sector to the taxpayer only make the final resolution more gut wrenching, difficult, and expensive. All roads lead to the breakup of the EMU. Better to do it now, in a controlled and orderly way, rather than let the happenstance of random events cause it to happen in the midst of a market crash.

Robert Barone, Ph.D.

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.

October 18, 2011

Seven Reasons Bank Stocks May Keep Falling

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 10:22 PM by Robert Barone

  • Occupy Wall Street – while not a cohesive movement, at least part of its birth can be traced to outsized Wall Street salaries and bonuses, especially since the taxpayer saved most of the TBTF banks.  Bank Transfer Day (11/5), the day on which Americans are supposed to transfer their deposits to community banks, is more symbolic than real, as the “Too Big To Fail” (TBTF) banks core consumer deposits are only a small portion of their liabilities and can easily be replaced with no or low cost funding from the Fed or elsewhere.  Nevertheless, Bank Transfer Day is a PR issue for the large banks;
  • Margin squeeze – TBTF have used the arbitrage spread between borrowing costs (near 0%) and Treasury yields (2%+) to profit.  And, the purchase of Treasury securities requires no capital under the capital regulations, as Treasuries are “risk free.”   The Fed’s new policy of “Operation Twist” targets  longer term interest rates and squeezes this arbitrage spread;
  • Volcker Rule – this has recently been put out for comment by the FDIC.  It severely limits trading profits made for the bank’s own account and is likely to have a big impact on TBTF trading profits going forward;
  • Debit card monthly fees – although such fees are a direct consequence of the limitation on debit swipe fees by the Fed under Dodd-Frank, and it was common knowledge that the TBTF banks would find a way to increase fees elsewhere to make up for their losses on the swipe fees, the timing has turned out to be lousy and the TBTF banks are taking a PR hit from the press, and even from the sponsors of Dodd-Frank who clearly knew that there would be unintended consequences;
  • Exposure to Europe – According to Michelle Bachmann, the U.S. TBTF Banks have a $700 billion exposure to European Banks.  So, a freezing up of liquidity flows to those institutions may have an impact on the value of such holdings.  It is clear that the Fed and the European Central Bank will intervene with massive liquidity injections if such events unfold.  Nevertheless, the risk of such a freeze up exists.  Furthermore, if contagion spreads because of a Greek default, there is no doubt that the TBTF equities will be negatively impacted.  So far, we have seen the equity prices of these behemoths ebb and flow with the news (or hope) out of Europe regarding their evolving “rescue” plan;
  • Mortgages & Foreclosures
    • Foreclosures at the TBTF institutions are rising because moratoriums have expired and “robo” issues have been addressed.  In addition, so called “Prime” loans in portfolios (usually “Jumbo” loans – those that are larger than the FNMA limits) are becoming a big issue as there is a clear trend toward rising “strategic” foreclosures.  In fact, Fitch recently downgraded many of these “prime” mortgage pools.  This calls into question the quality of what may be on the TBTF balance sheets in the form of such jumbo loans.  Furthermore, the fact that FNMA and FHLMC reduced their loan maximums on October 1st is destined to have a huge negative impact in states like CA and FL, where the prices of higher end properties will fall due to the unavailability of financing.  So, expect “strategic” defaults to rise rapidly in these states;
  • Lawsuits
    • Half of America’s mortgages are on MERS (Mortgage Electronic Registration System), but, in many states, MERS has no standing in foreclosure.  Theoretically every owner of a securitized pool should sign off on each foreclosure in the pool.  There could be hundreds, if not thousands, of owners in these pools.  In addition, many jurisdictions require that title transfers be recorded in county recorder offices.  Since that did not occur, lawsuits are now being developed against the major TBTF players for lost recording/title transfer fees.  The Dallas DA recently sued MERS and BAC for $100 million of such fees.  According to Mark Hanson, since MERS has been operating since 1995, there could be billions of dollars of such thwarted fees.   Because nearly every local governmental entity is hungry for funds, this could catch on like wildfire;
    • Bank of America’s (BAC) $8.6 billion global servicer settlement is in trouble, as NY’s AG Schneiderman says it should be closer to $25 billion, and he is getting support from other states, like CA.  The rumor mill has circulated the theory that if lawsuit settlements become outsized, BAC appears to have the option of bankrupting the old Countrywide unit, which it has kept as a separate legal entity since its purchase in 2008.  Imagine, though, the market reaction to such a move!
    • Lawsuits on mortgage trustees are just starting.  According to Bloomberg, US Bank, Bank of NY Mellon, Deutsche Bank, Wells Fargo, HSBC, BAC and Citibank (C) are the major mortgage trustees.  Bloomberg speculates that since these institutions didn’t underwrite, sell, securitize, service, or ship loans according to regulations, the odds are low that the trust departments got it right.  So far, NY’s Schnedierman has requested documents from Deutsche Bank and Bank of NY Mellon.
    • In early September the Federal Housing Finance Agency (FHFA), the receiver for FNMA and FHLMC, sued BAC, C, JPMorgan Chase (JPM), Barclays, HSBC, Credit Suisse, and Noruma Holdings demanding refunds from these institutions for loans sold to FNMA and FHLMC that were based on false or missing information about the borrowers or the properties.  The FHFA said that the two mortgage giants purchased $6 billion from BAC, $24.8 billion from Merrill Lynch which is now owned by BAC, and $3.5 billion from C.
    • Lawsuits and foreclosure issues are making the TBTF banks sorry they are in the mortgage business.  JPM’s Dimon announced that they are going to be leaving the mortgage business, and BAC announced last week that by year’s end they will stop buying mortgages from correspondents.

Not all of this appears to be priced in the market, so there may be continued downward pressure on the prices of financial stocks, especially TBTF, as events unfold, especially the potentially disruptive forces that Europe may unleash, or the conclusion that the foreclosure and mortgage lawsuits are larger and more significant than currently believed.

Robert Barone, Ph.D.

October 12, 2011

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A).   A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778

October 10, 2011

Buy and Hope

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 10:10 PM by Robert Barone

Despite a preponderance of evidence, the markets continue to rely on the “hope” that Europe will solve its enormous financial issues, that the U.S. will somehow miraculously begin to grow at or above GDP potential, and that the emerging markets will continue to grow by exporting to the developed world.  There are those on Wall Street still pushing “buy and hold” indicating to clients that, based on forward earnings forecasts, the equity markets look cheap, as if those forward forecasts aren’t subject to downward revisions.  Thus, the “buy and hold” is really “buy and hope.”  There are no quick fixes to any of the economic problems so evident in a world awash in debt.


  • Europe is clearly entering a recession, and is likely to be in it for an extended period.
  • The value of the sovereign debt of the European periphery countries is a huge issue.  Greece can afford to pay “normal” interest rates on about 20%-30% of its current debt.  Therefore, when its inevitable default occurs (looks like soon), the haircut on its external debt may be as high as 80%.  Once the default is announced, the markets will pounce on the next weakest – at this time, that looks like Italy, although Portugal and Spain are also in the race..  To keep Italy from defaulting, the Troika (the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF)) may have to finance Italy’s deficit and purchase its debt rollover for as many as 3 years.  The rollover of central government debt alone is €705 billion. The regional debt is also significant. The risk is that Germany or one of the other 17 European Monetary Union (EMU) members balk.
  • The real issue revolves around the European financial system.  There isn’t enough capital in it to mark the sovereign debt they hold on their books to market values.  The haircuts given to the peripheral sovereign debt when a Greek default occurs will cause an ugly reaction in the financial markets.  Huge liquidity infusions from the ECB (and likely the Fed) will be required.  Morgan Stanley says that €140 billion in new capital is needed, but I have seen estimates as high as €800 billion.
  • Discussions among Europe’s finance ministers about using the European Financial Stability Fund (EFSF) as a Special Purpose Vehicle to provide liquidity or to provide capital to the banking system (the discussion seems to change on a daily basis) have caused the financial markets to rise on such hope.  As far as I can tell, the €780 billion of capital that is being voted upon by the 17 EMU members (14 have approved so far) could be used as capital to lever up to higher levels and use the resulting funding for either or  both liquidity and capital.
  • This is all still in discussion stage.  Somehow, Greece miraculously found funds to keep itself solvent until mid-November, so the European finance ministers have kicked the can down the road for another month.  The real risk here is whether or not the Europeans can agree.  History is not on their side.  Unlike the U.S., the EMU requires unanimous consent and monetary contributions from each of its 17 members to cope with unusual circumstances not envisioned in the EMU treaties.  Malta and Cyprus have the same veto power as Germany.  It should be noted that, as of this writing, the Slovakia vote on an expanded EFSF is not a sure thing, and that Finland received special guarantees for its approval vote.  Imagine the chaos if every small member demanded special treatment – it could look like the earmark system used in the U.S. Congress.
  • Italy was recently downgraded 3 notches by Moody’s, from Aa2 to A2 with a negative outlook.  The Credit Default Swap (CDS) market believes Italy is still significantly overrated, as is most of the rest of Europe.  CDS may not be the best indicator of financial stability, but it appears that there are enough skeptics on European sovereign debt to make investors wary.  If much of Europe eventually gets downgraded, what kind of rating will the EFSF’s debt have?
  • In its current form, the EFSF must wait for a support request from a member country, and then must get unanimous consent from the 17 finance ministers.  (I smell gamesmanship in the form of holdout for special concessions – just like Finalnd!)

As you can see, the machinery is quite cumbersome and very slow to act.  Things must go flawlessly for Europe to avoid significant calamity over the next few quarters.  The excitement recently seen in the equity markets appears to be based on hope – not a very reliable investment strategy.

Japan and the Emerging Markets

  • Japan has too much debt coupled with deteriorating demographic trends.  Since the 1990s, they have not addressed the issues on their banks’ balance sheets, and real estate prices (land) have continued to decline for those two “lost” decades.  Their August industrial production numbers were weaker than expected.  Don’t look for Japan to lead. Their two decaded economic malaise may, in fact, be what is in store for Europe and the U.S.
  • There are also troubling signs in China and the emerging markets (BRICS).  HSBC’s PMI index for China has been below 50 for three consecutive months (below 50 implies contraction).  Whatever the case, growth is clearly cooling, most likely indicating some success in China’s fight against rising inflation, especially in real estate where prices are now flat to falling.  This, of course, is having a significant impact on natural resource and commodity prices.
  • It is unlikely that China, which still has positive, but slower, growth, will repeat the stimulus package they unleashed in ’09.  That helped the rest of the world climb out of recession.  The rapidly falling prices of industrial commodities (e.g., copper) is symptomatic of the slower pace of growth in the emerging world.
  • Some emerging markets, like Brazil, which have been fighting the inflation caused by the influx of capital from the developed world, are now seeing declining growth rates, most likely due to the slowing growth in the developed world which has a huge impact on emerging world exports and prices.

United States Housing Market

  • Housing normally leads the U.S. economy into recession, and then leads it out.  Not so this time.  Housing issues are getting worse, not better.  Prices, especially those of higher end homes, continue to fall, even with mortgage rates at historic lows (below 4% for 30 year fixed).  Qualifying is now extremely difficult and requires a large down payment.  On October 1, FNMA and FHLMC lowered the maximum amounts they will lend.  Since they purchase over 90% of all new loans made, this will significantly lower sales volumes, and eventually prices, in high priced areas like California.
  • Foreclosure trends are on the rise, both because the financial institutions have worked their way through the “robo” signing issues, and because most foreclosure moratoriums have expired.  Given the sorry state of housing, more and more underwater homeowners are simply giving up on ever seeing positive equity again.  “Strategic” defaults are on the rise.  These occur when a homeowner who can afford the payments walks away because the mortgage balance is significantly higher than the home’s value, and the owner believes it will be years, if ever, before he breaks even.  As a result, Fitch has recently lowered the ratings on what used to be called “prime” mortgage loans causing some dislocations in mutual and hedge funds that specialize in holding such non-agency paper, especially the ones that also use leverage.
  • Lawsuits are proliferating around mortgage issues.  The Mortgage Electronic Registration System (MERS), a private corporation with about 50 employees, claims to hold title to about half of the mortgages in the U.S.  They have filed foreclosure actions on behalf of the mortgage “owners” (there could be several hundred or even thousands of owners of a securitized pool).  Many jurisdictions require the “owner” to file the foreclosure.  Imagine having to get signatures of everyone that owns a share of a securitized mortgage pool each time one of the mortgages in the pool goes into default.  In addition, many jurisdictions require that title transfers be recorded in county recorder offices.  Since that did not occur, lawsuits are now being filed against major private sector mortgage purveyors (like JPM, or WF) for lost recording/title transfer fees.  The Dallas DA recently sued MERS and BAC for $100 million.  According to Mark Hanson, since MERS has been operating since 1995, there could be billions of dollars of such thwarted fees.
  • Mortgage trustees are also not immune from lawsuits.  According to Bloomberg, US Bank, Bank of NY Mellon, Deutsche Bank, Wells Fargo, HSBC, Bank of America, and Citibank are the major mortgage trustees.  Bloomberg speculates that since these institutions didn’t underwrite, sell, securitize, service, or ship loans according to regulations, the odds are low that the trust departments got it right.  So far, NY AG Schneiderman has requested documents from Deutsche bank and Bank of NY Mellon.
  • The $8.6 billion mortgage servicer settlement that Bank of America thought was a done deal has now fallen apart.  NY’s AG, Schneiderman thinks that the settlement should be closer to $25 billion.
  • With all of the lawsuits and the state of housing, the large mortgage originators are sorry they are even in the business.  Jamie Dimon recently announced that JPMorganChase may be leaving the business.  In early October, Bank of America announced they would stop their correspondent mortgage business by year’s end, which means that they won’t be buying mortgages originated by others.  One more nail in housing’s coffin.

So, let’s review: 1) Home prices continue to fall; 2) FNMA and FHLMC lowered their loan maximums; 3) Foreclosures are rising; 4) Lawsuits are proliferating on private sector lenders; 5) large private sector lenders are either leaving the business or curtailing it.  So, how is it that housing can lead the way out of the economic funk?

Other U.S. Indicators

  •  70% of GDP in the U.S. is from consumption.  The fact that real consumer income (after inflation) has fallen for three months in a row and is no higher than it was in 1997 is a very troubling sign because credit can no longer be used to consume.  In the months in which we actually see consumption rising, we see the savings rate fall.  Increasing consumption in an economy with falling consumer income can only last as long as there is savings.  So, it can only be a short-run phenomenon.
  • Washington, D.C. finds it impossible to come to terms with their overspending.  Nothing they have done, including the $1.5 trillion “Supercommittee” mandate will make a dent in the entitlement spending increases coming at us like a speeding train.  We know no changes in the entitlement rules will occur before 2013, at the earliest.
  • What is occurring at the Federal, State and Local levels is significant belt tightening.  President Obama’s Jobs Bill was DOA in Congress.  Because of the tax increases proposed, the Democrats even had a difficult time in finding a sponsor to introduce the bill.  With the funds provided in the ’09 stimulus package now gone, with a Congress not interested in more tax and spend, and with the Fed now out of real ammunition, there isn’t going to be much government help for a weakening economy.
  • Sarbanes-Oxley, Dodd-Frank, Obamacare, EPA pronouncements, other regulatory burdens, the uncertainty surrounding taxes and tax rates etc. has led to an environment of business uncertainty.  Under such conditions, there is virtually no chance that labor markets will pick up anytime soon.  As a result, consumer confidence continues to bounce along well below traditional recessionary levels.



The preponderance of the evidence makes it clear that the risks in the equity markets are to the downside.  There are no quick fixes to any of the European or U.S. problems.  Europe’s financial issues can easily morph into a worldwide financial panic.  The U.S.’s housing, deficit, and employment issues will linger without a new approach, one that we won’t see until at least 2013.  Safety is clearly a better investment strategy than hope.

Robert Barone, Ph.D.

October 10, 2011

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

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A).   A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.


October 3, 2011

Kicking the Can: The Issue of Bank Capital

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 10:36 PM by Robert Barone

In the last quarter century, each and every time politicians have “kicked the can down the road” in order to buy time to protect their banks (with the false hope that there will be a “Deus ex Machina,” i.e., a miracle), the resulting pain is much worse than if the problem had been addressed head on and resolved, even if painful at the time.  You can look at this in many ways, including the deficit and entitlement issues in the U.S.  But, I am going to limit myself to the financial realm in this particular essay.

Kick the Can: The S&Ls

In 1984, I gave a presentation to a group of senior citizens regarding what I saw as the insolvency of the S&L industry.  In social conversations, my wife often recalls the reactions of many of those seniors, many of whom had Certificates of Deposit at S&Ls (back then, interest rates were significantly higher than today’s paltry rates).  I suspect that the local heart specialists were busier than usual the next day.

The S&L can was kicked down the road for five more years.  It wasn’t until a new President (Bush #1) was inaugurated that the problem was addressed – that was 1989.  By then, the problem was significantly larger than it was in 1984 when even I could recognize the issue.  Because the can was kicked for five years, America went through an unnecessary and grueling recession in the early ‘90s, in which the financial system teetered and required government intervention.  Truth be told, however, the allowance of the S&Ls to abuse deposit insurance (or at least not appropriately pay for the risk they were layering onto the insurance system) and lack of oversight by the regulators (sound familiar?) should take much of the blame.  However, by ’89 the crisis was addressed, S&Ls were closed, and the bad loans on their books were dealt with.  Because the bad loans were written off, the financial system stabilized and enabled the economy to grow and prosper for much of the rest of the decade.

Kick the Can: Japan’s Banks

At about the same time (1989) Japan’s bubble burst.  In 2002, then Fed Governor Bernanke, criticized the Japanese approach to their banking issues in a famous speech about how the Fed would not let a Japan style deflation happen in the U.S.  Beginning in 1989, the Japanese regulatory agencies did not, and to this day, have not required Japan’s banks to recognize the losses on their underwater real estate loans.  When banks get into a position of knowing they have problem assets, they become quite reluctant to expand their loan portfolios and take on new risk.  Oftentimes, the regulators, recognizing that they have dropped the ball in the first place, become overbearing and shackle the banking system.  More than two lost decades later, Japan’s real estate (land) prices are still falling, and economic growth remains sluggish, intermixed with frequent bouts of recession.

Kick the Can: Too Big To Fail

The financial crisis in the U.S. in ’09 was also met with can kicking.  The “Too Big To Fail” (TBTF) banks that were allowed too much leverage in the period leading up to the crisis were all saved with taxpayer dollars. This time, however, the problems were not met head on as they were in ’89.  In fact, Dodd-Frank has now codified TBTF – those institutions are now called SIFIs, Systemically Important Financial Institutions.  And, America’s banks are back to playing the leverage game, this time with complicity from Washington, which depends on them to purchase newly issued debt.  By the way, that debt requires no underlying capital, an issue we will see later in this essay that has come to the forefront in Europe.  In the ’09 crisis, the shadow banking system (non-deposit taking lenders) was destroyed, and because the remaining small business lenders, America’s community banks, still have major asset issues, small business lending has dried up.  Today, as in Japan, economic growth is sluggish and the economy continuously flirts with recession. (I can’t blame all of the sluggishness in small business lending on the supply side because clearly the demand for small business loans is down due to the uncertain economic outlook that pervades America today.)

Kick the Can: Save the Bondholders

One major mistake of Japan, and of the so-called solution to the ’09 financial crisis, is that bondholders of most of these failing institutions, who took the risk of their investments, have not been asked to take the losses.  Except for FNMA and FHLMC, even the preferred shareholders of the failed megabanks (Wachovia, Washington Mutual, Merrill Lynch) were saved.  Why was it so important to save these stakeholders?  Did we really fall for the concept that if their bondholders lost money, then the economy would totally collapse?

Kick the Can: European Bank Stress Tests

Today, Europe’s banks are teetering on the edge.  This past Spring’s round of “stress tests” were a joke meant only to assuage the markets.  The sovereign foreign holdings of Greek, Irish, Portuguese, Spanish and Italian debt were all counted at par with zero capital required against these assets.  It is clear that the European banks are in desperate need of capital, and the shutting down of calls for such capital from knowledgeable and respected individuals doesn’t really fool anyone.  So, why are the Europeans about to throw good money after bad in a futile attempt to keep Greece from defaulting, and, once again, kicking the can down the road?

By forcing further “austerity” on the Greek economy in order to give them enough aid to pay the upcoming round of bond maturities at par, and therefore “saving” those particular bondholders, they are just prolonging the whole issue.  Even more austerity will further undermine the Greek economy causing ever widening deficits.  So, why are the bondholders so sacred?  The answer, of course, is that the European banks hold huge positions in the sovereign debt of Greece and the other high debt European Monetary Union (EMU) nations.

Kick the Can: Liquefy European Banks

With huge volumes of such debt on their books, each financial institution has become leery of its brethren, and interbank lending has begun to dry up.  As a result, The Fed, the European Central Bank (ECB), the Swiss national Bank, the Bank of England, and the Bank of Japan, in a coordinated effort in mid-September, began making dollar swap lines available to the European banks.  It appears that the Fed is involved because of Bernanke’s view of the Fed as the world’s central bank, and because of the fact that the vast majority of America’s money market funds hold large amounts of European bank commercial paper or other debt as assets.  Thus, instability of the European banking system could potentially touch off another credit market freeze in the U.S. and worldwide.  Yet, despite these interventions, within a week those very same liquidity strains have begun to re-emerge.

Kick the Can: Greek Default Inevitable

In the end, a Greek default is inevitable.  The math on this is too compelling.  Even if Greece could balance their budget pre-debt service, the debt service cost alone, even at reasonable interest rates, doom them to years of depression.  For Greece, default is really the best road.

Default is also better for the rest of the EMU.  Better to use the funds that are now going to pay off bondholders of Greek debt at par to help recapitalize Europe’s banks.  In the long run, this is cheaper and it addresses the underlying issue, European bank capital.

As for Greece, they, and even the other weaker EMU countries, can go back to their own currencies, and, if they so choose, peg them to the Euro.  If they run large fiscal deficits, the pegs can always be adjusted.

Dealing with Greek Default

A Greek default, of course, risks a financial panic in the markets.  To deal with such contagion, the ECB or the EFSF (European Financial Stability Fund) or some pan-European or international entity with credibility, should specify which countries are Tier I EMU countries, which are Tier II (Italy and Spain),and which are Tier III (Greece, Portugal, Ireland).  Tier III countries should be planning an imminent, but orderly, exit from the EMU with ECB and EFSF support of their bonds at some price well below par.   Tier II countries should be given some time and support (in the form of an ECB or the EFSF bond purchase program at par) to get their fiscal houses in order.

The inevitable Greek default is going to have a worldwide impact even if done in an orderly, thoughtful, and coordinated way. (If not planned properly, expect very high volatility in the financial markets.)  And financial institutions in the U.S. will not be spared the effects of such a default.  If the European banks appear in danger, U.S. money market funds, and very likely some of the SIFIs with loans to European banks, will be hard hit by market action.  We have already seen the beginnings of this.

More Capital – the Reason for Basle III

It should be obvious by now that many of the largest worldwide banks need more capital.  Yes, even those in America.  (Consider the recent BAC denial of its need only to obtain capital within a week of the denial!)  The need for capital is why we have Basle III.  Unfortunately, the Basle III timeline is too lengthy, as the capital is needed now.  Without new capital, much of the developed world will suffer the fate that Japan has suffered over the past two decades and now present in the U.S., with banks too worried about capital levels to want to take on additional risk in the form of business loans.  Well-capitalized banks at least remove the constraint of loan availability when conditions are right for economic growth.

Robert Barone, Ph.D.

September 26, 2011

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A).   A copy of the Brochure may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.


September 14, 2011

Proper Policy and Economic Growth

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 10:52 PM by Robert Barone

As indicated in a previous blog post entitled “Why the U.S. Can’t Grow Its Way Out Of Its Budget Jam”, , if GDP growth is as slow as PIMCO’s “new normal” would indicate, then even if the Congress could muster the ‘political courage’ to fix the budget and entitlement issues, lack of growth will trump that effort.  The first issue is that we have a government that doesn’t understand why the economy isn’t growing, and, in fact, promotes policies that inhibit such growth, such as overregulation, interference, and the promotion of more debt as the answer.  The second issue is the structural inability of the economy to grow.  The two issues are closely related.

Policy Gimmicks

Since the Great Recession began (and some believe that it still has not ended) policy makers have used various gimmicks to try to kick start the economic engine.  On the fiscal side, we have seen programs like cash for clunkers or first time homebuyer tax credits that simply have pulled demand forward rather than stimulating new demand.  On the monetary side, Bernanke and the Fed, deathly afraid of “deflation” (we can’t understand why falling prices are worse than rising prices – falling prices make incomes go further, rising prices do the opposite!) have managed, through their policies, to significantly raise the dollar prices of food, energy and related commodities.  Meanwhile, those policies have not halted the significant deflation in housing and its surrounding industries.  From a consumer point of view, the things that they own continue to fall in value, while the things that they need to purchase have risen in cost.  How are they better off after QE1, QE2, and most likely, QE3?

The Key To Growth

One critical issue centers around the level of debt of the American consumer, especially relative to income.  Most of America’s larger corporations have already lowered this ratio and have lots of cash to spend.  Thus, we have witnessed the relatively good performance of the share prices for most of these non-financial entities since 2009.  But the U.S. consumer, without job opportunities, is in a different class.  Demand cannot grow without a healthy consumer.  And, without rising demand, the economy simply stagnates. Some who say they have studied the Great Depression and some commentators today, believe that World War II was the primary factor that pulled America out of depression (see Paul Krugman, “Oh! What a Lovely War!”, New York Times, August 15, 2011).  But think about this: after World War II ended, why would there be an increase in demand?  What had changed? (Yes, there was demand from war torn Europe and Japan.  But I don’t think rational folks would advocate that we destroy assets, our own or those owned by foreigners, so that we can rebuild them.  Don’t forget, when an asset is destroyed, a loss to someone has occurred. If insured, the owners of the insurance company pay; if not, the owners of the property pay.)

Why the Great Depression Ended

The build-up of debt over the 16 years ended in 2008 is similar to the same phenomenon of that occurred in the 1920s.  During World War II, there was rationing and forced saving.  People of that generation often talked about the fact that they couldn’t buy a car, or tires, and that gasoline was rationed. Rationing forced the populace to save and pay down their debt, so that, by the end of the War, the consumers’ debt/income ratios were once again healthy and there was the capacity to increase consumption.  Of course, the rationing caused a huge build-up of pent-up demand.

Table 1 shows consumer debt outstanding for selected years prior to and in the aftermath of the Great Depression.  Table 2 shows a similar growth path in consumer debt and debt as a percentage of GDP from 1992 to 2008.

Table 1 – Consumer Debt, Its Growth Rate, and Its Relationship to GDP

The Great Depression


Consumer Debt

(Billions $)



Consumer Debt/





















Table 2 – Consumer Debt, Its Growth Rate, and Its Relationship to GDP

The Great Recession


Consumer Debt

(Billions $)



Consumer Debt/













Note the rapid rise in consumer debt in the 1920s followed by rapid contraction during the initial years of the Great Depression.  Then, debt grew rapidly again until 1941, at which point it contracted rapidly during the war effort due to rationing and the unavailability of consumer goods.  Note that the ratio of consumer debt/GDP was lower in 1944 than it was in 1920.  What had changed during the War was a significant reduction in the indebtedness of the American consumer.

No such rapid consumer debt reductions are evident in the Great Recession, at least not through 2010.  There has been some reduction as shown in Table 2.  But, we believe this is due more to mortgage defaults than to actual consumer debt repayments.  Note the rapid declines in debt in both the 1929-33 and 1941-44 periods.  Reductions of that magnitude are not present in the current economic climate, and some government policies (cash for clunkers, and foreclosure moratoria) discourage debt reduction.  Given what was necessary in the debt area for the consumer to pull the U.S. out of the Great Depression, it appears that we have quite a long way to go in the current environment.

What Policy Can Accomplish

The key to economic growth is rising demand.  This doesn’t happen when existing roads are repaved or unemployment benefits are extended because demand falls back as soon as the road project is finished or the unemployment benefits run out. And, if the funds came from Washington, all we’ve done is raise the level of debt for the sake of current consumption.  If fiscal policy is to be used to stimulate demand, there are several directions it should take.  Today, America suffers from high and rising real costs of energy at a time when real incomes have been stagnant and debt to income ratios have strangled consumption growth.  A fiscal policy that promotes the development of cheap energy now would 1) create jobs, 2) put cash back to America’s consumers via lower gasoline and energy bills, 3) improve America’s balance of trade, and 4) provide less cash to middle-east oil nations and impede their ability to finance terrorism.  We do believe in alternative energy sources when they make sense.  But, the U.S. has an abundance of oil, natural gas, coal, and nuclear technology know how.  Those are the areas that will immediately help the real economy, and, perhaps, reduce the need to send our young people to fight on foreign soil.  Ask yourself why the unemployment rate in North Dakota is 3.3%.  The answer: oil and agriculture.  From 1976 to 2010, Canada’s unemployment rate averaged 8.5%.  In July, it stood at 7.2%.  The reason: Canada has become a major exporter of oil (to the U.S.!) and natural resources.  Consumer confidence there is much higher than similar measures in the U.S.  And its deficit/GDP is half.

Policy Interference

The second way fiscal policy can positively impact U.S. economic growth is to reduce government interference in business.  This isn’t only a federal issue, as state and local governments do their part to harass small business.  But, let’s face facts: the banking system is nearly nationalized with “Too Big To Fail” (now codified in Dodd-Frank as SIFIs -Systemically Important Financial Institutions) allowing the giants to take excessive risk while government regulators strangle the entrepreneurial spirit of most community banks.  For sure, the government is the only real player in the mortgage market through the bankrupt FNMA and FHLMC entities which control 90% of the market (while losing billions of dollars every month).  Additional regulation via Dodd-Frank and the encouragement of and participation in lawsuits against those private companies still in the mortgage business has already, or will soon, reduce private sector participation in mortgages just when the economy needs a recovering housing sector.

Housing Leads

Housing has always led the economy into recession.  But, it has always led it out.  Not this time.  The mortgage pendulum has swung from one extreme (breathing qualified one for a 125% LTV mortgage) to the other (huge down payments, high income/payment ratios, and a near universal requirement to qualify for sale to FNMA or FHLMC, which, as of October 1 will have lower maximum loan acceptance levels).  The promotion of a universal mortgage refinance idea being bandied around Washington may stimulate some demand as consumers who get lower rates and payments may have more monthly disposable income, but what has been forgotten, or conveniently not discussed, is the loss of that cash flow to the investors who own the mortgage instruments.  In other words, this is just an income redistribution scheme which may not produce many jobs because the owners of the now lower yielding mortgage paper are more than likely the job creating entrepreneurs.  The real issue here is the continued downward spiral of home prices.  The policies followed in Washington have simply prolonged the pain.

Tax Code Gibberish

The personal income of one of the authors is derived from wages and consulting income.  Yet, his tax return is more than an inch thick, costs $1,500 to produce, and is a maze of incomprehensible gibberish.  This is symptomatic of the unnecessary and burdensome set of rules that the federal government has imposed on its citizenry.  Because Dodd-Frank and the Obamacare legislation have yet to be fully implemented, we can expect higher costs and more job killing rules and regulations.

The Private Sector Creates jobs

The real creation of jobs occurs in the private sector, by the private sector, not in government or by government.  Policy can encourage or discourage such job creation.  More than any other era in our lifetimes, government policy has discouraged private sector job creation.  Today, like in the 1930s, consumers need to reduce their debt burdens.  Policy cannot do this directly.  The gimmicks used thus far have pulled demand forward, have taken from one set of citizens and given to another, have increased the debt which will reduce future consumption, or have inflated food and energy prices via money creation.

However, proper policies can encourage economic growth.  Unfortunately, there is no “instant” cure.  Equally unfortunate, a Presidential election is but 14 months away, and that “instant” cure is what is being sought.  What America needs are policies that encourage and promote cheap energy, reduce government regulation, a complete reformation of the tax code, and the encouragement of debt reduction all while addressing spending and entitlements.  The track record in Washington to accomplish this is nil.  It’s no wonder that the price of gold continues its ever upward path.

Robert Barone, Ph.D.

Matt Marcewicz

September 12, 2011

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


September 13, 2011

The “New Normal” May Trump Political Courage

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 10:23 PM by Robert Barone

There are two huge issues facing the American economy today.  The first is a government that doesn’t understand why the economy isn’t growing, and, in fact, promotes policies that inhibit such growth, such as overregulation, interference, and the deployment of more debt as the answer.  The second issue is that inability to grow.  The two issues are closely related.

Despite Promises, Federal Spending is Out of Control

In looking at the trends in the Federal budgets, especially over the last decade, one word comes to mind – gold!  Despite all of the hand wringing and promises about spending cuts, it just doesn’t happen.  According to the Wall Street Journal (August 24), CBO projects that total Federal spending for fiscal year 2011 (which ends at the end of this month), will be $141 billion higher than 2010, and even higher than that of 2009 which was supposed to be the temporary spending peak.  The growth in Federal spending just for 2011 will be 4% higher than that of 2010.  Furthermore, exactly one month after the brouhaha over the debt ceiling in which a “temporary” debt ceiling cap some $400 billion higher was enacted, we find that the total debt has again exceeded the ceiling (Zerohedge, Déjà vu All Over Again…, 9/2/11).  Growth in Federal spending over the 50 years ending in 2010 has been at a compounded annual rate (CAGR) of 6.5%, while the growth rate of GDP during that same span was 5.7%.  Everyone knows that continual growth in Federal spending that exceeds the growth in the economy is simply unsustainable.  This, of course, has all come to a head because in the last 10 years, Federal spending grew at a CAGR of 7.1% compared to a CAGR of GDP of 3.9%.

Growth Rate of Entitlements

It isn’t a secret that the biggest issue in Federal spending is the so-called “entitlement” issue (although some object to the characterization of some aspects of “entitlements”, having contributed to Social Security and Medicare for all of their working lives).  Defining “entitlements” as “transfer payments” from the government to individuals, and going back to 1960, we find that such “transfers” were 26% of Federal tax collections.  Since then, those “transfers” have grown at a CAGR of 7.8%, while tax receipts and the economy have grown substantially more slowly, 5.6% and 5.7% respectively.  Thus, in 2010, “entitlement” payments were over 92% of Federal tax receipts.  That percentage was 64% as late as 2007, and has grown because of the demographics of Social Security and Medicare, but more so because of a massive jump in “Income Security” payments (defined by as Supplemental Security Income, Earned Income Credits, Unemployment Compensation, Nutrition Assistance, Family Support, Child Nutrition, Foster Care, and Making Work Pay).

Current Trends Mean Exploding Debt Ratios

Table 1 extrapolates current budget, tax and demographic trends using the underlying assumptions shown, most of which are drawn from CBO estimates for 2015 and then extrapolated further.

Table 1: GDP Growth = 3% CAGR




Fed Budget


Tax Receipts



























1) Social Security and Medicare expenditures per capita are from CBO 2015 estimates of approximately 1.6%.  The same CBO expenditures per capita are extrapolated to 2035.
2) CBO estimates that the 65+ age cohorts, as a percentage of total population, will increase from 21% in 2011 to 36% in 2035.
3) Population growth extrapolates the .94% CAGR for the decade ending in 2010 throughout the forecast period.
4) “Entitlements” in the model are defined as Medicare/Medicaid, Social Security, Income Security, and Federal Pensions per the definitions found at
5) Federal Pensions are projected by CBO to grow at a CAGR of 2.5% through 2015.  The table above extrapolates that CAGR throughout the forecast period.
6) Taxes/GDP rise from 15.1% in 2011 to 18.0% (near the 50 year mean of 18.3%) and remain at 18% for the forecast period.
7) The Federal budget grows at a 5.3% CAGR (per CBO) to 2015 after which its level is fixed as a percentage of GDP at that 2015 level.
8) The “Income Security” portion of “entitlements” shrink under CBO assumptions as “Unemployment Compensation” is assumed to fall.  After 2015, the Table assumes this category to grow at a CAGR of 1%.
9) Defense budget growth is 1.7% annually.

Because CBO assumed that the spike in “Income Security” that has occurred since ’07 would largely dissipate by 2015, the “entitlement” ratios shown in Table 1 all shrink until 2015.  However, despite the low (optimistic) 1.6% growth in per capital Social Security and Medicare expenditures of CBO, the “entitlement” ratios rise rapidly after 2015.  Worse, even under this extremely rosy set of assumptions, including the return of the tax take to 18% of GDP by 2015, the deficit as a percentage of GDP remains unsustainable, and the Debt/GDP ratio rises inexorably.

What Political Courage Means

Given this base case scenario, what do the Washington politicians have to do to fix the situation.  Table 2 uses the same model as Table 1 with the following changes:

  • The Social Security and Medicare growth rates are reduced from 1.6% to 1.0% over the forecast horizon;
  • The CAGR of the “Income Security” category is reduced from 1.0% after 2015 to 0.5%;
  • The CAGR of Defense spending is reduced from 1.7% to 1.0%;
  • The CAGR of Federal Pensions is reduced from 2.5% to 0.5%;
  • Total Federal spending only grows at a CAGR of 0.5% over the forecast horizon;
  • The tax take as a percent of GDP rises to 19%;
  • GDP growth remains at a CAGR of 3% over the forecast horizon.

Table 2: GDP Growth = 3% CAGR




Fed Budget


Tax Receipts



























As is evident from the table, if the Washington politicians can find the courage to make hard decisions around the growth rate of “entitlements” and put itself on a no growth (0.5% – likely less than the rate of inflation) budget (still giving Washington 21.5% of America’s GDP, an historically high number), all of the critical ratios either slow their climb or reverse course.  Yet, even under such a politically unlikely scenario, many would say that even the outcome shown in Table 2 is not acceptable.

The “New Normal” May Trump Political Courage

Critical to this analysis is the growth rate of the GDP.  Clearly, a faster rate than the 3% shown above would have better results.  But a faster growth of GDP implies higher rates of inflation, and it is unlikely that the spending assumptions for Table 2 could be accomplished in an environment with significant inflation.  In real terms, the CAGR of GDP has been 3.1% over the 50 year period ended in 2010, but only 1.6% since 2000.  Recently, PIMCO’s Bill Gross stated that he believes that the U.S. has structurally changed such that nominal GDP growth will average between 0% and 2%.  Literally, this is more of the same anemic growth that we have seen in the U.S. since ’07.

Table 3 embodies the same assumptions as Table 2 except the CAGR of the GDP is reduced to 1%, per PIMCO’s view.

Table 3: GDP Growth = 1% CAGR




Fed Budget


Tax Receipts



























Thus, even if the Washington politicians can summon the courage to do what they have never been able to accomplish in the past and slow the growth of “entitlements” and its own profligate spending, the debt and deficit levels remain unacceptable if the economy grows in nominal terms at PIMCO’s “new normal.”  This threatens the U.S.’s status in the world, and certainly the dollar’s role as the world’s reserve currency.


It is imperative that U.S. economic growth return to its historic path of 3%.  And even then, the economic results depend on the level of political courage from the Washington pols.  To accomplish a return to economic health, fiscal and monetary policies must first return to balance.  Fiscal policy must refrain from the gimmicks used in the recent past, like cash for clunkers or homeowner tax credits, which have simply pulled demand forward, and monetary policy must stop monetizing the deficit.  Rather, the encouragement of investment through a rational and sane tax policy (e.g. flat tax or national sales tax), a reduction in government interference in the private sector (e.g., Dodd-Frank, the EPA, and Obamacare), and the use of policy to encourage the development of the nation’s natural resources (e.g., cheap energy) would be a good start to revive the nation’s economy.  But, as an election year approaches, doesn’t the word “gold” ring true?

Robert Barone, Ph.D.

Matt Marcewicz

September 6, 2011

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


August 19, 2011

The Mortgage Market – An Impediment to Economic Growth

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 9:54 PM by Robert Barone

The lack of clarity surrounding U.S. and worldwide economic growth certainly played a big role in the recent Wall Street sell off.  In part, it was precipitated by the “debt ceiling” prank that was played upon the country and the world, especially after the market dissected the deal and found that, through the use of smoke and mirrors, economic growth (and therefore tax revenues) was assumed to be 4%, a growth rate that is hard to fathom, at least for the U.S. and Europe, given the financial landscapes in these two major consuming regions.

Housing & GDP

Housing is a case in point.  The direct contribution of Residential Fixed Investment to GDP was 4.8% in 1990, 5.2% in 2000, and 6.1% during the housing boom of 2005.  In this year’s first half, it registered 2.2%, the lowest level since records have been kept.  This measure of housing’s impact on GDP significantly understates its importance.  Ancillary to housing are such things as furniture and furnishings, appliances, demand for utilities, demand for other services such as landscape and repair, etc.  Then there is the multiplier impact of the earnings of construction workers as they spend those incomes in the course of everyday living.  It can be said with a high degree of certainty that U.S. economic growth will be weak until housing returns to some semblance of health.  Historically, changes in housing construction have contributed significantly to the business cycle, both to pushing the economy into recession, and to lifting it out.   In most post-WWII recessions, a housing turnaround usually starts before the recession ends.  Given the state of housing today, is it any wonder why the U.S. economy is at stall speed?

The Swinging Pendulum

In 2005 and 2006, if you could breathe, you could get a mortgage loan with little or nothing down and just your word on whether or not you could afford the payments.  But today, just when the economy needs a growing housing sector, the pendulum has swung to the other extreme.  Not only have most mortgage companies disappeared, but the criteria to qualify for those that are still in business are the strictest they have ever been.  In addition, Congress and the states have now placed many obstacles into the mortgage lenders’ paths including the promotion of legal actions against the largest mortgage lenders (or their successors) and the provision of legal aid, in the form of obstacles to the foreclosure process, to underwater homeowners who have quit making payments.

  • Bank of America (BAC) has tried to extract themselves from the litigation cesspool resulting from their acquisition of Countrywide with an $8.5 billion global settlement, which still has to be approved by the court. (Just think – BAC purchased this garbage heap without any government assistance – does this say something about BAC management?)  But, NY State’s Attorney General has decided that $8.5 billion is completely inadequate, indicating that the settlement should be in the $22 to $27.5 billion range.  At the same time, AIG is planning to sue BAC for $10 billion on the grounds that the mortgages it purchased from Countrywide were misrepresented (whatever happened to due diligence or buyer beware, especially for “sophisticated” investors?).
  • With all this going on, it isn’t any wonder that Jamie Dimon has decided to remove JPMorganChase (JPM) entirely from the mortgage business.  Dimon has proven over the years that he is an industry leader, so, his withdrawal from the mortgage business may be an omen of things to come.
  • Meanwhile, states are passing legislation aimed at “helping” consumers, but with vast unintended consequences for the mortgage markets.  Don’t misunderstand – I am not arguing in favor of the mega banks and Wall Street who have significant responsibility for the current state of housing in the U.S.  But, litigation and legislation could have the unintended consequence of further slowing and postponing any housing rebound:
  • According to Mark Hanson of M Hanson Research, California recently passed legislation prohibiting second lien holders from filing deficiency judgments in short sales.  Immediately JPM pulled all of their short sale second lien buyout acceptances, which forgive significant second lien deficiencies for a price of $3,000 to $5,000, and is now asking for 50% of the note amount.  This will nullify the short sale and force the first lienholder to foreclose, now giving JPM the right to a deficiency judgment.  Such legislation may have an adverse and unintended consequence of scuttling the short sale market in California, just when real progress was being made.
  • Nevada leads the nation in underwater mortgages.  Zillow reports those numbers are as high as 80% in Las Vegas and 70% in Reno.  To deal with this, the last Nevada legislature passed legislation which prohibits a first lienholder from collecting a deficiency judgment on a primary residence short sale.  This means that everyone underwater can walk away without significant consequences and presages even more short sales and foreclosures.  In addition, another law prohibits note holders who purchased mortgage notes at a discount from collecting more than they paid for the note in a foreclosure process.  The consequences of such interference can potentially be disastrous for the secondary mortgage market.  Taken to its logical conclusion, no one would be willing to purchase troubled loans at a discount because the best return possible is just a return of capital.

Bank Capital

Another drag on the mortgage market, and, in fact on the market for all non-government guaranteed private sector loans, is the push on the part of regulators to drive bank capital levels higher.  Too much leverage along with the repeal of Glass-Steagall certainly played a large role in the global financial crisis, whose second act is currently on stage in Europe.  Bank capital and liquidity ratios are now under close scrutiny, and the Basle III accords will require banks to hold significantly more capital and in purer form.  To “preserve” their capital and meet the stricter requirements, banks will prefer to invest in items exempt from the capital requirements (like government guaranteed paper) rather than placing assets in areas requiring high capital retention.  (The spenders in Washington appear to be quite comfortable with this!)  The unintended consequence here will be fewer “risky” loans, and those that are made will be at much higher interest rates to compensate for the additional capital required.

Qualified Residential Mortgage (QRM) and Qualified Mortgage (QM)

The Dodd-Frank legislation is also in the process of imposing significant restrictions on mortgage lenders.  One Washington lawyer, Laurence Platt, recently remarked that “the natural consequence of QM and QRM is that only the most privileged borrowers in our country will be able to get mortgage loans…”

QRM requires lenders to meet strict underwriting standards, which will be written into Fannie Mae and Freddie Mac guidelines.  Failing that, the lender must retain 5% of the credit risk if the loan is sold or securitized.  QRM requires a minimum 20% down payment and very low debt to income ratios.  The FDIC has indicated that approximately $8.5 trillion of currently outstanding mortgage loans would not have qualified under these guidelines.  Lenders have testified that any non-QRM loan would be very expensive for consumers.

More scary is the QM standard which prohibits such things as negative amortization loans, loans with balloon payments, or loans with terms exceeding 30 years.  But the kicker to QM, as proposed, is that there are severe legal and monetary penalties to lenders if it is determined that the borrower did not have the “ability to repay” at the time the loan was originated.  Even “unintentional” violations can be fined at $5,000/day.  Imagine what the legal profession is going to do to this “ability to pay” standard.  I suspect that the fact that the home went into foreclosure will be a strike against the lender under QM.

Clearly, both the QM and QRM compliance nightmares discourage the reappearance of the small mortgage companies that dotted our landscape just a short 5 years ago.  Only the large institutions can afford the compliance here, and, as discussed above, they have other significant impediments to being in the mortgage business.

Fannie and Freddie Cutbacks

The bankrupt Fannie Mae and Freddie Mac, which currently purchase more than 90% of mortgages made today, are significantly reducing their loan maximums effective October 1.  This can’t be anything but negative for the mortgage markets.  As these two behemoths continue to cost taxpayers billions of dollars every month, sooner or later (certainly not until after the 2012 elections) their losses will have to be addressed.  Fannie and Freddie alone, in the current environment, cannot support a growing mortgage market with reasonably priced mortgages, a requirement for the U.S. economy to prosper.

Where are the Cash Down Payments?

According to Zillow, 26% of mortgages in the U.S. are underwater with some markets significantly higher.  Mark Hanson has made the point several times that when short sales or foreclosures occur, the former homeowner generally has no cash or resources to use as a down payment on another home.  (No wonder apartment REITs are booming!)  This alone culls the pool of potential home buyers.


In the end, the impediments to the mortgage market appear significant: litigation, new consumer “friendly” legislation, higher bank capital requirements, QM and QRM compliance issues, and lower maximum loan amounts from the bankrupt Fannie Mae and Freddie Mac entities are all coming together at once.  The reduction of the availability of mortgage money is a certainty.  In addition, a large swath of consumers with underwater mortgages and those with excessive credit debt burdens simply have no funds for the down payments that will now be required under the Dodd-Frank legislation.  Under such conditions, it is likely that home prices will continue their downward spiral and new home construction will continue at record low levels.

As stated at the beginning of this piece, housing has historically led the economy out of recessions.  Not this time!  Without a healthy housing sector, economic growth is significantly constrained.  Under these circumstances, the idea of 4%, or even 3%, economic growth reappearing in the U.S. anytime soon is a dream only Washington politicians can harbor.  The reality is that without a healthy housing sector, even 2% long term growth seems like a stretch, and the economy will remain vulnerable to outside shocks.

Robert Barone, Ph.D.

August 15, 2011

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

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A).   A copy of the Brochure may be obtained by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778

Next page