Fin/Inv

Ella ja Aleksi is a Finnish musical group featuring two four-year-old rappers .

This video for the song “Yöjuna Rovaniemelle” is adorable:

hat tip boingboing

Submitted by Geoffrey Batt.

May 2004

Ben Bernanke and Vincent Reinhart (who until 2007 was Director of the Division of Monetary Affairs for the Board of Governors of the Federal Reserve System) publish “Conducting Monetary Policy at Very Low Short-Term Interest Rates” in The American Economic Review.  How, they ask, can a central bank effectively move beyond conventional policy measures when short term rates are at or approaching zero?  Bernanke and Reinhart suggest three strategies:

1. Convince market participants rates will stay low for a period beyond current expectations
2. Change the composition of the central bank’s balance sheet (credit easing)
3. Increase the size of the central bank’s balance sheet to a level exceeding what is necessary to achieve zero short term rates (quantitative easing)

Strategy #2 is radically aggressive insofar as it contemplates altering the composition of a central bank’s assets- which, in non-crisis conditions, consists almost entirely of Treasuries of various maturities- to include other, perhaps even riskier assets.  For instance:

As an important participant in the Treasury market, the Federal Reserve might be able to influence term premiums, and thus overall yields, by shifting the composition of its holdings, say, from shorter-to longer- dated maturities.  In simple terms, if the liquidity or risk characteristics of securities differ, so that investors do not treat all securities as perfect substitutes, then changes in the relative demands by a large purchaser have the potential to alter relative security prices.  The same logic might lead the central bank to consider purchasing assets other than government securities, such as corporate bonds or stocks or foreign government bonds.  (The Federal Reserve is currently authorized to purchase some foreign government bonds but not most private-sector assets, such as corporate bonds or stocks.)1

October 31, 2008

In the context of rapidly deteriorating market conditions, Jan Hatzius, Chief US Economist for none other than Goldman Sachs publishes “Getting to the End of the Rate Cut Road” in US Economics Analyst.  With overnight Fed Funds at 1%, Hatzius argues the time for more aggressive monetary policy may be at hand.  Specifically:

…Fed officials could start to purchase risky asset[s] such as corporate bonds and even equities.  At present, such an aggressive approach is legally quite problematic, as the Federal Reserve must not take on a material amount of default risk.  Thus, the purchase of risky assets would probably require an explicit stamp of Congressional approval.  Should the economic and financial environment continue to deteriorate, however, it would be foolish to rule out such a more radical approach.2

November 14, 2008

Hatzius publishes “Marco Policy in a Liquidity Trap” in US Economics Analyst, advocating still more radical policy measures.  In his words:

The most radical step would be debt- or even money- financed purchases of risky assets such as nonconforming mortgages, corporate bonds, or equities… Policy makers could focus specifically on the mortgage market, buying up mortgages or entire mortgage-backed securities in size, restructuring the terms on a loan-by-loan basis, and then holding the loans to maturity.  Alternatively, they could target risky assets more generally- private-label mortgages as well as corporate bonds, equities, and potentially a whole host of more exotic securities.  Especially, if such a program were financed by money creation, it would be considerably more radical than anything seen previously.  Hence, the hurdle for adoption is high one, and the political scrutiny in Congress would likely be intense.  Nevertheless, we believe it could become a serious possibility should the economic and financial slump deepen in 2009.3

November 21, 2008

Hatzius publishes “What’s Needed to Stop the Rot?” in US Economics Analyst reiterating his call for unconventional policy action even while noting that it currently sits on shaky legal ground.  That is:

…the Congress should consider providing explicit authority to either agency [Treasury or Fed] to buy a broader range of risky assets, including corporate debt and even equities.  Although many politicians have difficulty swallowing this on philosophical grounds, this week’s market action should convince them that the risks of inaction are serious.  However, such a more radical step is unlikely until sometime in 2009.4

March 13, 2009

Chaos reigns globally.  Respected academics and high ranking politicians call for bank nationalization.  CNBC reports of “secret” meetings at Goldman Sachs amid fears Geithner cannot get the job done.  US equity indices are down more from their highs than the corresponding period in The Great Depression.  Pension funds, 401k plans, endowments, insurance companies, etc., are fully exposed, taking heretofore unimagined losses.  With nearly everyone in the country exposed to equities in one way or another, the unthinkable begins to seem increasingly plausible.  Insurance companies cannot pay claims; pension funds cannot meet their obligations; universities suspend session; Mr. and Mrs. Smith, told just months earlier an unprecedented $700 billion bank bailout was designed to save them and their neighbors on Main St., stand to lose everything.  The Fed, having thrown just about everything in its arsenal at the crisis, appears to be losing control.  In the most desperate of times, Hatzius calls for the most desperate of measures:

…Fed officials might need to expand their balance sheet by as much as $10 trillion to make policy appropriately accommodative (pg. 2)…To be sure, “quantitative easing”- an increase in base money beyond what is needed to keep the funds rate at zero- by itself may not be sufficient on its own because Treasury bills become perfect substitutes for base money once short-term interest rates have fallen to zero.  But the Fed can engage in “credit easing” by purchasing assets whose yields are still positive, including longer-term Treasuries, commercial paper, mortgages, corporate bonds, and perhaps even equities.5

Five days later, the Fed shocks the world (though not, it seems, Goldman Sachs) with its most aggressive policy action yet, expanding both the size and composition of its balance sheet via increased purchases of mortgaged-back securities, agency debt, and long-dated Treasuries.  Spreads immediately tighten; Bonds- both IG and HY- scream higher; equities stage one of the most explosive rallies in history; the debate shifts from bank nationalization to record bank profits and excessive pay; financial collapse, along with the terrifying social, political, and economic consequences associated with it, is averted.  The war, we are confidently told, is over.

Mission accomplished.

Questions, however, still remain:

1. Forget the "Paulson Bazooka," if Lehman’s collapse was a financial Pearl Harbor, was the Fed’s policy response on March 18, 2009 the financial equivalent of Fat Man and Little Boy? (The direct purchase of equities?)
2. In the face of the unthinkable, did the Fed exceed its policy statement by directly buying assets not contemplated therein?
3. Did Bernanke, encouraged by Goldman’s Hatzius, heed his own advice and monetize the equity markets?

At best, the evidence offered here is circumstantial.  This is not, to be sure, conclusive proof the Fed bought equities- nor is it intended to be.  All I have endeavored to do is raise a rational doubt, one that could easily be done away with if Bernanke answered (finally) under oath direct questions as to the Fed's purchase of equities at any point during his tenure as Chairman.  Perhaps Alan Grayson might put his worries about foreign currency swaps to the side, and ask Chairman Bernanke about equities.

(The author would like to acknowledge the generous help of Zero Hedge's Marla Singer in the production of this article).

1. 1. The American Economic Review, Vol. 94, No. 2., p. 86. (Emphasis ours).
2. 2. "US Economics Analyst," Vol 08, Number 44, Goldman Sachs, October 31, 2008, p. 6.
3. 3. "Macro Policy in a Liquidity Trap," US Economics Analyst Issue 8 Number 46, Goldman Sachs, p. 6. (Emphasis ours)
4. 4. "What's Needed to Stop the Rot?" US Economics Analyst, Issue 08, Number 47, Goldman Sachs, p. 3.
5. 5. "The Specter of Deflation," US Economic Analysis, Issue 09, Number 10, Goldman Sachs, March 13, 2009, pg.3. (Emphasis ours)

Vor den Wahlen in NRW laesst die neue Koalition aus Schwarz und Geld nur einige Katzen aus dem Sack. Andere noch ungerechtere werden folgen. Es wird noetig einen Katalog der sozialen Gemeinheiten in Fortsetzungen zu schreiben. Hier die erste Ausgabe, nachdem heute der Koalitionsvertrag veroeffentlicht wurde.

It's game over for Capmark, which is expected to file for bankruptcy within 24 hours. The firm which was formerly GMAC's commercial real estate business (Or GMAC Commercial Holding Ccapital Markets Corp in short), and had originated over $10 billion in CRE loans (by the way, did we say that CRE REITs are undervalued? if you didn't buy at least 5 shares of some multi-apartment or hotel REIT yesterday with every share of Amazon you were covering you are a bubble uninflating traitor and have to be shot for not believing in a 100x P/E), was LBOed by KKR and Goldman in 2006. Needless to say, that particular investment won't be making the next Calpers pitch book.

Hopefully at least Warren Buffett will make off like a bandit:

Capmark recently entered an agreement to sell its North American servicing and mortgage-banking operations to a new company owned by Warren Buffet's Berkshire Hathaway and Leucadia National Corp. for as much as $490 million. Under the deal's terms, the sale could occur while Capmark is in bankruptcy, but would require a bigger cash payment.

The other question is how this bankruptcy will impact Ms. Bair's soothing message that all is well with the banking system.

Adding to Capmark's pressures, the Federal Deposit Insurance Corp. had notified the company that it must raise capital and boost liquidity at its Utah bank, which has roughly $10 billion in assets.

The bank would not be part of Capmark's bankruptcy filing, a person familiar with the situation said.

Maybe not tomorrow, but give it a few weeks. If the operating company was specialized in underwriting the kinds of loans that were responsible for a $1.6 billion second quarter loss, one can imagine that GMAC's bank which in May changed its name to Ally to cover its tracks, can't be far behind, especially not with Ally desperately trying to poach depositors as recently as 4 months ago with abnormally high interest rates. Zero Hedge previously wrote about the ABA's complaint against Ally: if Ally was that desperate for deposits that it would pay far higher rates then, one can only imagine how bad things must be. And with $10 billion in assets getting the traditional 30-40% haircut, there goes another $4 billion that the insolvent FDIC does not have.

Commercial real estate continues to show signs of extreme stress. Please consider Capmark Said Ready to File for Bankruptcy.

Capmark Financial Group Inc., one of the nation's largest commercial-real-estate lenders, plans to file for bankruptcy as soon as this weekend, a person familiar with the situation said.

The much-expected move underscores the deep problems in the business-property market. After suffering from the collapse in residential mortgages, U.S. banks face steep losses from commercial real-estate loans. Capmark has originated more than $10 billion in commercial real-estate loans, according to Moody's Investors Service.

It also represents a blow to the company's private-equity owners. In 2006, a group led by KKR & Co., Goldman Sachs Capital Partners and Five Mile Capital Partners acquired the lender GMAC LLC's commercial-real estate business and renamed it Capmark. As of March 31, the investor group owned about 75% of the company, with GMAC and its employees owning the balance.

The Horsham, Pa., company recently reported a $1.6 billion second-quarter loss and warned it might be forced to seek Chapter 11 bankruptcy protection. KKR has already written down its investment in Capmark to zero.

Adding to Capmark's pressures, the Federal Deposit Insurance Corp. had notified the company that it must raise capital and boost liquidity at its Utah bank, which has roughly $10 billion in assets.

Capmark Financial Pours $600 Million into its Ailing Bank

Inquiring minds are reading Bank Watch: Capmark Financial Pours $600 Million into its Ailing Bank

Capmark Bank, the wholly-owned Utah industrial bank subsidiary of Capmark Financial Group Inc., agreed to a cease and desist order with each of the Federal Deposit Insurance Corp. (FDIC) and the Utah Department of Financial Institutions. The orders require Capmark Bank to maintain a Tier 1 leverage ratio of at least 8% and a Total Risk-Based Capital ratio of at least 10%.

Capmark Bank reported $11.1 billion in assets as of June 30 and net loss of $261.3 million.

Capmark Bank’s nonperforming loans and foreclosed property assets increased by nearly $240 million from the first quarter to the second quarter and now totals nearly $631 million. About 78% of those assets are related to commercial real estate.

State Arbitrage Game Gone Mad

Joe Weisenthal writing for the Business Insider was on top of this story back in September. Please consider Commercial Real Estate May Kill "Well-Capitalized" Capmark Bank.

Capmark Financial Group, one of the largest commercial real estate lenders in the US, said this week that it was seeing huge default rates and that it could be headed for bankruptcy.

It's the latest in a string of decently-sized, non-Wall Street banks that appear headed for the dustbin of history (or into Sheila Bair's loving embrace)

What caught our eye in Bloomberg's report Capmark Distress May Signal Bank Failures Topping 100 was this paragraph:

Capmark’s holdings include a banking unit based in Salt Lake City with $11.1 billion in assets and a “well- capitalized” ranking from its regulators, according to the bank’s Web site. Deposits stood at $8.4 billion on June 30, according to the company’s quarterly statement.

Two things stand out:

Regulators described it as "well-capitalized," which means that they were totally behind the curve.

Capmark is based in Pennsylvania, but capitalized in Utah, making it one of several banks to have set up in the state for regulatory arbitrage purposes. If we're going to eliminate multiple Federal regulators, we might as well get rid of states, too, since shopping around for favorable states may be just as big of a deal as shopping around to be regulated by the Office of Thrift Supervision.

Capmark Bank was not in the first 100 banks to fail but it appears to be a rock solid bet for the next 100.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

This has been coming for some time ...

From the NY Times Dealbook: Capmark, Big Commercial Lender, May File for Bankruptcy

The Capmark Financial Group, the big commercial real estate finance company cobbled together from pieces of GMAC, may file for bankruptcy as soon as this weekend ... The company is only the latest to fall victim to continued trouble in the commercial real estate market ... Capmark has about $10 billion in assets, with another $10 billion in a Utah bank the company owns that would not be subject to a bankruptcy filing.

Capmark bank in Utah is in trouble too, and is the fifth largest bank (in assets) on the unofficial problem bank list.

From a Capmark press release in September:

The FDIC has notified Capmark Bank that it intends to issue an administrative order, which will impose certain requirements and restrictions on Capmark Bank, including requiring submission of capital and liquidity plans, restrictions on affiliated party transactions and other activities.

As the Galleon inquiry expands, we have been fairly certain that the dominoes would start falling. Whether or not one of these dominoes would be the fund that single-handedly defined the term "information arbitrage" is still anyone's guess, although as the WSJ reports today, a former employer of Stevie Cohen's until the year 2004, Richard Grodin, has received a subpoena for his trading records as part of the Galleon case. It appears that upon learning of the Feds sniffing around his 500 Fifth Avenue office, Mr. Grodin promptly shut his current hedge fund and got out of dodge.

Richard Grodin is (or rather was) head of SEC unregistered Quadrum Capital Management, which as Dealbreaker disclosed a few days ago was forced to promptly shut down, meaning that Mr. Grodin was well aware the allegations were about to start flying, and that judging by the haste of the shut down, there is much more to the story than mere allegations. Attempts by Zero Hedge to reach any of its principals listed below have so far been futile. One person who is sure to be saddened by this is Doug Leggate, Citi's former #2 oil analyst, who in the summer of 2008 left Citigroup to join the now defunct fund.

The common link in the case appears to be cooperating witness Choo Beng Lee, who worked with Grodin at another SAC-sponsored hedge fund called Stratix which was closed in 2007.

From the WSJ:

Mr. Cohen runs SAC's main hedge fund and has invested money on behalf of his investors as well as his own money in funds run by former SAC managers. Over the years, Mr. Grodin has worked as a portfolio manager for SAC, as well as a division that invested SAC investors' money. He also ran a separate independent fund in which Mr. Cohen was an investor.

It is unclear which specific trades of Mr. Grodin's and their timing are being sought. The 6-foot-5 Mr. Grodin, 40 years old, took time away from his hedge fund this summer to play in a basketball tournament in Israel, a person familiar with the matter says.

Mr. Grodin and Choo Beng Lee, who has been identified as a cooperating witness in the government's case, have ties that stretch back to the late 1990s when the two worked for SAC, people familiar with the matter say. Mr. Grodin was a portfolio manager and Mr. Lee was an analyst that worked with him.

Several years later, Mr. Grodin broke away from the main SAC fund to work at Sigma, an SAC division, where Mr. Grodin continued to work as a portfolio manager and Mr. Lee continued to serve as an analyst for him. Mr. Lee's lawyer declined to comment.

Mr. Grodin later launched a hedge-fund named Stratix outside of SAC's sphere, in which Mr. Cohen was an investor. At Stratix, Mr. Lee worked for Mr. Grodin for several years, according to people familiar with the matter. Mr. Grodin closed Stratix in December 2007.

How many more people will be uncovered as a result of this sting operation is unclear, although our bet is that much more than just 10 will ultimately be implicated. And just as all roads lead to Rome, all cases of insider trading ultimately are the result of some form of information arbitrage. Whether a publicity shy Mr. Cohen will have an official statement regarding his relationship with Grodin is as of yet unknown. Then again ole' blue eyes, who enjoys closing his multi-billion dollar fund flat at the close of each trading day, may just have bigger problems on his hands these days.

I did an interesting interview with Marketplace Radio on why mortgage mods fail so often.

>

Download MP3

>

click for Interview text

>

Source:
How to get off the mortgage treadmill
Marketplace Public Radio, October 23, 2009
http://marketplace.publicradio.org/display/web/2009/10/23/mm-mortgagemods/

>

>

Bob Moon: This economic mess started with the subprime mortgage crisis. People couldn’t afford their mortgages, banks tightened credit, the rest is history, right? Well it would be. Except we’re still there. The ratings agency Fitch said this week that over half of all mortgages modified to help people stay in their homes go right back into default in a matter of months. Seems we’re on a mortgage treadmill and that does not spell relief for the economy.

Barry Ritholtz of Fusion IQ joins us now. Welcome to the program.

Barry Ritholtz: Thanks for having me.

Moon: I’m visualizing trying to hold back a big landslide that just keeps coming and coming and then, just when you think you have a control, there’s another slide somewhere else. What are these numbers really mean for regular people and for the broader economy?

Ritholtz: Well, understand what we’re looking at when we’re talking about a mortgage modification. We begin with a home owner, or as some people call them “home ower,” that’s in a house, but doesn’t have a whole lot of equity. The house is now worth considerably less than what they paid and their mortgage, which they were hoping to either refinance or somehow work around, has become an owner’s burden.

So they’ve been unable to get out from behind too much house. And so you end up with a series of incentives and a series of steps designed to prevent foreclosures from taking place. But the bottom line is, many people are in homes they just can’t afford and there’s not a whole lot you can do to prevent a foreclosure, unless you reduce the amount that owed. And very few banks seem to be willing to do that.

Moon: And if these number’s don’t change, then we are just going to continue to see more and more defaults?

Ritholtz: The foreclosure picture looks fairly negative for the next, let’s call it 12 to 24 months. We’re now absorbing about 300,000 foreclosures a month. That’s a pretty severe number compared to historical norms, about three million a year. I wouldn’t be surprised to see another five million foreclosures before housing really stabilizes and gets healthy.

Moon: I thought that we had all these programs in place though, that were supposed to not just stop foreclosures, but to keep them from happening in the future

Ritholtz: What the data has shown us is that when they enter one of these modification programs, that on average, somebody — without real delinquency in their mortgages — who go through a modification, about 50 to 60 percent of those people end up 12 to 18 months back in behind the eight ball, behind their mortgage. And people who go into a mod, already delinquent 30, 60, 90 days behind, they’re going into foreclosure at very high rates, at 75 to 80 percent.

Moon: So this number over half of all modified mortgages going back into default after only a few months. Should that be telling us something?

Ritholtz: Yeah, it’s telling us that modifications aren’t going to work. Unless you’re going to make the house appreciably less expensive for that home owner, for most people that are going through modifications, it’s just a temporary stop gap. It doesn’t solve the underlying problem. These minor changes around the margins — lower interest rates a little bit, reduce the payment slightly, because we’re extending the term of the mortgage — they’re not addressing the fundamental issue, which is, literally millions of people ended up buying houses that they can no longer afford

Moon: What I hear you saying is “Let’s stop postponing the inevitable.”

Ritholtz: You know, it wouldn’t be the worst thing in the world to just tear the band-aid off, let house prices get back to their normal levels, relative to traditional metrics. I know it sounds cold and if you’ve ever spoken to anybody who’s gone through a foreclosure, it’s a miserable, miserable experience.

But from a macro perspective, looking at the entire country, it would be healthy for the economy, to see foreclosures go forward, to see home prices normalize. That would lead to more housing activity and that helps to create jobs. Until we start house prices get to a point that’s going to cause more activity in the real-estate sector, the whole economy is just more or less muddling along.

Moon: Barry Ritholtz with the online research firm, Fusion IQ, the author of “Bailout Nation.” Thanks for joining us.

Ritholtz: Thanks for having me.

Those who follow the meandering permutations of the Fed's balance sheet must have observed with great irony the proclamation by the NY Fed on October 19th that it is prepared to commence tightening liquidity via reverse repo operations, even as 48 short hours later later the Fed announced a new all time high in bank reserves, which for the first time ever hit a level over $1 trillion. The glaring discrepancy between these two observations has left many wondering not only about the veracity of any statements coming out of the Fed, but to consider what the best trades to front-run the Federal Reserve may be for that time when, whether it likes it or not, the NY Fed is forced (politically or otherwise) to start extracting its pound of flesh from the banking system.

The chart below demonstrates the dramatic pick up in excess reserves, which after lying relatively dormant around the $800 billion level, have shot up by over $200 billion in less than two months.

What is particularly notable is that the excess reserves hit a record level hours after rumors swirled that the Fed's reverse repo test conducted this Monday was a failure, and that instead of attempting to interact with banking institutions in a test attempt to raise $200 billion in liquidity, the Fed was forced to approach money market funds instead. Indeed, as Dow Jones reported, money market activity for the latest week would confirm speculation about major MM outflows, with $41 billion withdrawn from such funds, even as MM levels have continued to decline persistently, and hit a recent low of $3.339 trillion. With a 20 bps risk-free arb courtesy of the Fed deriving from MM record low rates at 0.05%, while the target fed-fund rate is at 0.25%, it is no surprise that capital will continue to flow toward the Federal Reserve.

It would probably require Sheila Bair to come out with another YouTube video in which she placates fears that money market investors are now collateralized by precisely the same toxic MBS garbage that banks, domestic investors, China and, most recently, Pimco have all decided to prudently keep far away from.

Not surprisingly, the primary source for bank reserve expansion continues to be the Fed's ongoing monetization of Treasurys and MBS. And even as the first is winding down, the second still has around $400 billion in dry powder left. Add to that the nearly $200 billion in additional liquidity that is forthcoming courtesy of the wind down of the Supplemental Financing Program, which is the Fed's latest "two birds with one stone" program of keeping the US debt ceiling from being breached, and allowing banks to purchase yet more risky assets, and Americans are easily looking at an excess reserve balance well north of $1.5 trillion within 3-6 months: money that should be lent out, but isn't. After all why take risks when you can make risk free money courtesy of the US taxpayer (the interest the Fed pays on the reserves comes straight out of the taxes Americans pay. Damn it feels good to subsidize Wall Street's kleptocracy class with every biweekly federal tax withholding). As for the party line, here is what the Fed says about funding excess reserves:

Why is the payment of interest on reserve balances, and on excess balances in particular, especially important under current conditions?

Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC, because the expansion of the Federal Reserve’s various liquidity facilities has caused a large increase in excess balances. The expansion of excess reserves in turn has placed extraordinary downward pressure on the overnight federal funds rate. Paying interest on excess reserves will better enable the Desk to achieve the target for the federal funds rate, even if further use of Federal Reserve liquidity facilities, such as the recently announced increases in the amounts being offered through the Term Auction Facility, results in higher levels of excess balances.

It is sad that the only way to keep deflation in check is to effectuate this kind of wealth transfer out of America's working class into the kleptocratic oligarchy. 

Yet perhaps the reverse repo approach will at some point prove successful (even if it did not this past Monday). Here is what market participants read between the lines from the NY Fed's October 19th reverse repo announcement:

1. Ensuring reverse repos will be ready when and if the FOMC decides to use it
2. Possibly expanding the set of counterparties in reverse repos
3. Expanding reverse repos to ‘triparty’ settlements

While the statement is traditionally broad and non-committal, Morgan Stanley does highlight one aspect of it:

We stress that neither did the NY Fed statement confirm that no reverse repurchase operations were in the works before year end, as it again has no capability to make such decisions. This is an important nuance that the market likely missed, which may cause it to misprice the tail risk of a near-term drain.

In other words the Fed may or may not do something or another, depending on what the callers from speed dial 1 through 5 (name your top 5 banks as sorted by declining amount of interest rate swaps in the trillions) instruct Bernanke to do.

An issue meriting further attention is the concept of triparty reverse repos. As Zero Hedge recently pointed out, the NY Fed has been so careless in using these in the past, that in the case of Lehman Brothers it actually used the stocks of numerous bankrupt companies as collateral for the $40 billion triparty repo backing up Lehman's balance sheet in the days after it filed for bankruptcy.

Here is Morgan Stanley's interpretation on what the use of triparty reverse repo will mean:

A tool that the NY Fed may ultimately rely on to drain large quantities of reserves is a triparty reverse repo. This is the least operationally intensive way for the NY Fed to drain large quantities of reserves from a large number of participants (currently only dealers but in time may include GSEs, money market funds & other institutions).

 

One effect of the Fed’s potential reliance on triparty reverse repos to drain excess reserves is that large quantities of collateral will be made available to the market – so if the Fed decides to drain say $200 billion of excess reserves, approximately $200 billion of extra collateral will be available for GC [General Collateral]. This will cause GC rates to rise, potentially above overnight fed funds or above OIS when speaking of term.

And in case investors would like to gradually step in against prevailing popular thought and take the other side of the Fed trade, on the assumption that at some point the Fed will be forced to stop printing trillions of new dollars, MS shares the following:

The fact that banks are not arbing out the risk-less spread between the overnight fed funds rate and the 0.25% overnight deposit rate at the Fed is another example of an ‘arbitrage’ that is often left on the table (Exhibit 2). In this case, one of the reasons that this spread has not collapsed to zero as banks compete to borrow below the deposit rate and invest it overnight at the Fed at 0.25% from the supply side is because credit line limits may be reached that prevent cash-rich non-bank participants from lending beyond a certain limit to the commercial banks. From the demand side, commercial banks may not want to increase the size of their balance sheet that would be involved in earning this spread. We mention this example in passing only to demonstrate that when and if the triparty repos are done in size , they may disrupt the historical OIS / GC spread relationship and seeming ‘arbitrage’ opportunities may not entirely keep this spread from inverting.

Therefore, if investors are not too comfortable with going short risky assets on the bet of liquidity tightening (the topic of a later post), a levered bet on an OIS-GC spread tightening may be one much less risky approach to play the contra-Fed strategy.

And some additional thoughts on this trade from MS, which believes that the market is certainly not discounting for reverse repos hitting the market any time soon:

Talk of reverse repos has added some uncertainty to the market, but front-end rates have barely budged. Since bottoming out at 0.13% at the start of October, the 6-month US T-Bill rate has remained near its lows at 0.16% (Exhibit 3). Meanwhile, the 3-month US T-Bill rate has not moved at all and GC to the end of the year is now lower than it was at the beginning of the month.

 

Further, most of the volatility remains further out the curve between the 1s/2s Treasury spread (Exhibit 4 - light blue) and not in the 6m/1y Treasury spread (Exhibit 4 - dark blue). This indicates that the market is no more worried about higher front-end rates in the very front end of the curve than it was at the beginning of 2009 – and continues to be more worried about higher rates / the level of curve further out in time, say in 1-years time.

 

This implies that investors who believe OIS / GC spreads will tighten can take advantage of current entry levels.

 

What the market is saying is that not only is the Fed not "in danger" of tightening any time soon, but that its disclosed preferred mechanism of liquidity extraction via reverse repos is not likely to be effectuated any time soon, especially in light of the failed Fed test on Monday. The "don't fight the Fed" ideology has become everyone's bedtime mantra. And as long as the Fed is willing to throw trillions simply for the sake of redefining triple digits P/E multiples as the new "normal," so be it. Madoff also thought he could run his scheme for ever. Either that, or he simply did not think about the consequences of what happens when the status quo changed. The Federal Reserve is now caught squarely in the same position. And, just like Madoff's ponzi scheme imploded with $50 billion disappearing overnight (and no, there was no greater fool to throw the hot potato to), so the same will happen with the US capital markets one day. The event is a certainty, the timing is still unknown - but keep an eye out on such data points as the OIS-GC spread for some early warnings.

Great Oxford talk economic historians Robert Allen, on why the Industrial Revolution actually occurred in Great Britain, and not France or the Netherlands or China:

Hat tip Paul Kedrosky

This week's comments are about why I continue to present the same data on investor sentiment week after week. Some readers have suggested that this data has been of little value during this historic bull run, and so why keep showing it. I believe the data has been relevant, but for those who see otherwise, let's just agree to disagree for now.

For the first time ever, at least half of all American workers are women. In addition, mothers are the primary breadwinners or co-breadwinners in nearly two-thirds of families.

These are the findings from a new report called The Shriver Report: A Woman's Nation Changes Everything, put out by Maria Shriver, wife of Arnold Schwarzenegger.

The Shriver Report will receive widespread media coverage this upcoming week.

While the mainstream media is heralding these findings as showing that women have achieved gender equality with men, the true meaning of these statistics is actually quite different.

As Wendy Norris, an investigative reporter based in Denver pointed out in a recent interview, the "equality" of women in the workforce is the result of the severity of the financial crisis and the resulting unemployment among men. Specifically, it is well-known that men have suffered the majority of job losses from the rising tide of unemployment hitting America.

Norris also points out that these are lower-paying jobs, as women typically earn less then men.

So what is being celebrated as a sign of progress and equality is actually an indication of the severity of the unemployment crisis in America.

To kick off this topic, let's go back to the post on how drama creates trauma: by sizing positions much larger than our norms, we create large swings in dollar P/L, which often translate into large emotional swings--and subsequent emotional damage.

If there is anything more frustrating than being wrong in the markets, it's being right--and then not participating in the actual moves.

Often this occurs because, in our drive to maximize gains, we can size positions so aggressively that we become unable to take normal heat when the market temporarily moves against us.

A great example occurred for me during Friday's trade. I was short from late Thursday and watched the market move against me overnight and then bounce sharply against me on the housing numbers Friday morning. Because I sized the position moderately, I could stand the heat, because I saw that we were not breaking above the multiday trading range. And if we had broken above that range, the loss wouldn't have ruined my week.

Had I been sized much larger, it's much more likely that I would have been spooked out of a good trade. When I'm sized reasonably, I'm willing to risk 5-10 ES points to make 10-20 or more. Sized to the max, I start to translate those 5-10 points into dollar terms--and that leads to scared, reactive decisions.

The purpose of the profit targets that I publish each morning before the market open via Twitter (subscribe here) is to provide a gauge for likely market movement. When I see strong selling pressure (negative NYSE TICK; large volume hitting bids in Market Delta) on enhanced relative volume, I formulate the view that we're likely to hit the S3 price level. My job at that point is to simply sit in the trade, make sure that the market dynamics are not significantly changing, and formulate an exit based on market behavior once my levels are hit.

If I'm processing how much I'm losing (on paper) on countertrend bounces, I'll never sit through the the pain of the gain and earn the reward that justifies my risk.

The ability to sit through a trade is greatly underappreciated. We tend to focus on entries, exits, and the next trade, and the next one--constantly looking for things to do. Sometimes, however, the most profitable strategy is to do nothing and simply let your trades work out. That requires a moderation of sizing/risk--and a kind of inner peace and satisfaction with the positions you have on and the bets you've made.
.

From James Hagerty at the WSJ: Uncle Sam Adds 5% to Prices of Homes, Goldman Says

Uncle Sam’s interventions in the housing market have pushed home prices 5% higher on a national average than they would have been otherwise, Goldman Sachs estimates in a report released late Friday.
...
But these artificial props won’t last forever and may have created a false bottom in the market. “The risk of renewed home-price declines remains significant,” Goldman economist Alec Phillips writes in the report, “and our working assumption is a further 5% to 10% decline by mid-2010.”

In the research note, Phillips discussed how policies have reduced foreclosures, and stimulated demand with both the first-time home buyer tax credit and "abnormally low mortgage rates". Phillips wrote (no link):

"In 2010, we expect some of these supports to fade. Fed and Treasury purchases of mortgage-backed securities will taper off, and the pause in foreclosures created by federal mortgage modification programs may end.

The federal tax credit for first-time homebuyers appears likely to be extended for at least a few months, but probably no longer than through the first half of 2010."

Based on Goldman's estimates, the first-time home buyer tax credit probably cost around $80,000 per additional home sold. Ouch.

The report isn't all negative. Goldman believes "the brunt of the price decline is behind us" and the outlook is uncertain: "the cloudy policy outlook adds to our already considerable uncertainty of where house prices will ultimately bottom".

This is very close to my view, see: The Uncertain Housing Outlook

Mike Santoli has an interesting perspective on the furious reactions to Goldie’s bonuses in this week’s Barron’s:

“Absent in the rage against people earning impressive pay after their firms got public help is the key question: Do we want the firms that received aid to continue operating as autonomous, profit-seeking businesses, or as quasi-utilities operating under tight government restrictions?”

That is the key disagreement I have had with those folks furious about the bonuses: The firms that paid back the TARP — do we never allow them to resume control of their businesses? Are they now “non profits?” Who is appropriate to determine their pay packages — their owners, board members and senior management — or the Government?

Santoli further suggests we consider the means and implications of explicitly limiting pay:

“Goldman, operating at less than half the leverage of a couple years ago, last quarter produced a return on equity well below what it logged in peak years. It set aside a much smaller portion of its revenue to employees last quarter than it typically has, 43%.

What if Goldman set aside half as much as it did for bonuses, say 20% of revenue. Where does the other half go? To the bottom line, where it builds up book value, which could allow Goldman to leverage a greater capital base and trade more and become even bigger in the markets it plays in, likely with fewer of the better people to oversee the risk as they could go find a new employer willing to pay. Or do we want to legislate away the chance for a Goldman to earn even what it did last quarter? Or require that the government get some percentage of the take? On what legal or practical basis, at this stage?

If Goldman weren’t exploiting the market opportunities it is, those opportunities would still be there, and others would get to them — whether other banks or hedge funds — and would pay their people (maybe some hired from Goldman) the big money.

Let’s get to the true heart of the matter” It is that these folks — many of whom are assholes — make oodles and oodles of money, much more than they would be permitted to if a munificent and just deity were paying closer attention to this little ball of earth and water:

“It has long been true that the “average” employee on Wall Street is overpaid, his or her bonuses dragged higher by those who make huge scores for their firm. The solutions — bonuses based on multi-year, risk-adjusted performance; “clawbacks” if trades go bad after bonuses based on them were paid; more pay in the form of long-vesting company stock — are being implemented by the remaining firms.This isn’t the same as saying “the market will sort it out,” but that any new rules or structural changes need to be considered from all the angles. And remember that the most important consequences of such measures are often the unintended ones.”

Interesting stuff, worth thinking about.

>

Previously:
Much Ado About Nothing $23B: Goldman Sachs Bonus (Oct 14, 2009)
http://www.ritholtz.com/blog/2009/10/much-ado-about-nothing-23b-goldman-sachs-bonus/

Goldman Sachs: “A Bunch of Clever Thugs” (Oct 15, 2009)
http://www.ritholtz.com/blog/2009/10/goldman-sachs-%E2%80%9Ca-bunch-of-clever-thugs%E2%80%9D/

Source:
Will This Week’s GDP Validate the Rally?
MICHAEL SANTOLI
Barron’s October 26, 2009
http://online.barrons.com/article/SB125633731314404773.html

Berk here…

with a mother-load indicator post.  Your browser will die (24 charts), but there was no real good way to display all this information at one time without killing your poor machine.  Just make the quick timely sacrifice, and you may feast upon the fruits inside.  I’ll be as fast as possible here, as these are mostly updated charts from The Bigger Picture (Browser Death Style).  I’ve posted the information important to the charts (i.e. my opinion) below the chart.   That said, let’s jump in head first.

$CPC never pulled back far enough for me.  The 10day hit the target range, but with no love from either the 20 or 50.  Not good enough for me…

$NYMO just rallied off a nice bottom in the 10day.  We need a push back to the upper boundary or we are just looking for another bottom (unless the bottom trendline breaks).

$NYHL keeps on trucking away.  Look for the 50day to act as support for the 10day (should we be so lucky).  A divergence would be suweet.

$NYAD has broken it’s uptrending lines, we should be looking for a retest in the 20 and 50day, and a spike in the 10day towards the Dec 08/Jan 09 highs.  That would set up another nice divergence.

$BPNYA is still stuck around the 80% range.  This is the market asking for trouble.  So close, but I am waiting for confirmation before sticking my hand back in the fire.  Should we break the MA cluster, and have the 10day start to drop, keep a careful eye on the slope of the 10day.  If we are REALLY dropping, it should fall off the plate.  No steep decline in the 10day, and we have another dip buying opportunity.

Look for MA support at each of the color-coded trendlines.  A double top is possible here (bearish sign fo’ shizzle) but confirmations comes below 40 (10day), 47 (20day) or 65 (50day).  Still a little way before we know for sure.  In the meantime, technically speaking, a push back to new highs would be screaming top, as 90+% of $SPX stocks would be above their 50day MA.

Flattening out (thank god, do we REALLY need to see 100% of $SPX stocks above their 200MA?) but this can last a while.  Notice the bottom where we put in a quad bottom before blasting off.  Watch for the 10day to start expanding it’s range, and we will know we are getting close.  50day was flat for 4 months before it took off from the bottom.  We are pushing 1 month here (if you stretch), but we could continue to see the 50day this high if we don’t pull back in a steep drop.  Like I said, watch the 10day to start acting a little more lively.

$BKX…  Yadda yadda channel, double top, yadda yadda.  Maybe, maybe not, but what will seal the deal for me is one of those LOVELY spikes.  I’m looking for somewhere in the 52.5 to 55 range.  We are at the bottom channel resistance right now…

Here is the Mystery Chart from a few days back.  A few of you guessed it, but here it is in the flesh.  $KRX is coiling away.  I favor an upside spike.  If it IS a triangle, we have our five three wave moves.  Either way it breaks it should be pretty telling (triangle or not).  Another thing I noticed was a interesting cup and handle fractal.  Not a firm believer, and definitely not a trader of cup and handle formations, but this would favor an upside resolution also.

A 4th wave after that massive 3rd wave should take some more time and price movement to retrace the prior move.  As I said before, I expect LQD to rally for a bit after the markets top.

I’d like to see a push back up into the 36-37 range where strong previous resistance would correspond with the down-sloping trendline.  Not sure what else to say here as I don’t want to elaborate on the multiple more months of rally we could see.

Not much to say here.  I think most of us are looking for a spike towards 1100 at the least.  There is a little pattern (yes, it looks like a flag or pennant, but that is not the point) that came about before the prior blow-off, where the MACD was showing equal highs (SLIGHT divergence in histogram) while $GOLD was pushing to new highs.  As we should be close to a blow-off peak, I can see this occurring.  Also, how many times to we see commodities consolidate around a high.  Just not feeling it yet.

From a charting perspective, I would really like to see a deeper retracement, and a blow-off.  Preferably while the market is dropping, corresponding to a blow-off in $GOLD.  But hell, that’s mental masturbation, AND bad for my wallet.  We got a little divergence, but nothing spectacular.  Next resistance is a bit above 85.

$INDU:$GOLD without waves.  Two potentials here that I will get in depth with in just a second.  Basically, we have a nice support range we are sitting on top of right now.  A drop into that without a rally above could create an ugly (poor) looking H/S top.  However, should the range truly be support, we should be looking for a move back towards the 11 range.  This would happen quickly if $GOLD were to drop while $INDU pushed to a high.

I said we would get into it, and here it is.  I am using $NDX because I have always believed that it offers a cleaner count.  $NDX:$GOLD ratio appears to be a step ahead of the game.  That means we are at a turning point here.  If the ratio continues to drop (equal highs and a marginally higher low right now) the top should be in.  If the ratio can hang on in a wave 2 (either minor or minute degree) or push to new highs in a 5th wave, we are likely 2 highs from a top in $SPX.

A little closer look at the potential wave count (and alternates) that I have running.

If we continue to consolidate sideways, we are still waiting for Godot.  If we can push up however, it should be a another bit of evidence pointing to a top.

Don’t worry we’re almost done.

Awfully near a speculative peak… MAs could be acting like they were at the ‘07 peak, or we could just be coiling for one final push.  While there is a divergence right now between the $SPX and $NDX:$SPX ratio, I cannot say with confidence that that is a bearish sign.  Last time it happened, we were topping minor wave 2, not at a new high.

The black boxes are to be ignored.  If $BDI can’t get above 3500, we would have ourselves more lower lows and lower highs.  Pushing above 3500 would strengthen the likelihood of a new high in $BDI and also $SPX.

$TRAN is in lockstep with $SPX.  Starting to fall off here, but it could just be a larger 4th wave before a final push up.  Wait for the double top to be confirmed, as you can see what happened the last 2 times we had that potential pattern.

Really close to being done.

$UTIL is stuck between a strong support and some thin air.  Not sure which one would be more likely to give.  I did mention last time I destroyed your browser, that the $UTIL has a habit of hanging around longer than the $SPX.  So if we do push into the wild blue yonder, that would not necessarily be bullish for the markets.  Right now, nothing is giving.

While GS (and perhaps the market with it) is likely due for a little more correction, I am not real confident we will make it through that support range.  We also have a rising trendline to add to that support.  IMO, we’ll see push above 200 (I know, shocking).

If we blast higher from here, the bottom is in.  If not, and by not, I mean, if by the open on Monday the /DX is not flying higher and not looking back, I would be looking for another low.  I’d really like to see a spike down and quick reversal (that would coincidentally correspond to a commodity blow-off), but hey, if I could control the markets right…

Again, thanks for the pretty charts Berk, but WTF does that mean.  That means that while the last time I posted all this, EVERYTHING was bullish.  This time, it’s much more of a mixed board.  At present, I am still leaning towards one final push at 1120.  However, a number of single indicators would quickly have me changing my mind if they flashed a signal.

Below however, is my biggest concern to the bearish case (120min candles).

As you can see, and should already be well aware of, we have a potential fractal setting up again.  We put in a high with a sideways retracement (4th wave) put in a spike high, followed be a sharp drop and steep rally.  Their is a final drop, and a trendline connecting the spike high to the rally peak creates the break-out.  If this is to be the case, we should expect some drop Monday morning, pushing outside the 2.0BB before riding the elevator back to (and through) the break-out level.  If this is a fractal, the current one is moving at a much more rapid pace than the others, just something to note.

A final thought.  Once we start to drop (in the next larger move down {P3 or whatever it may be at this point}) we should see a solid rise in the ATR of individual equities.  I am starting to see some of the smaller names flash this sign, but not enough right now, without the support of other indicators, to get too short.

Thanks for bearing with me through that.  It was a lot of info, and horrible for your computer, but I think we will all survive.  With that, I leave you to your weekend.  I have plenty more tickers and counts I will try to get up in the discussion board this weekend, but in the meantime, you have your topic(s), talk amongst yourselves.

Berkster out!

Killing a zombie fallacy about exchange rates.

Wired offers pictures of tricked out electric vehicles. Muscle car readers age 80 86 years old! You know who you are.

In recent posts, I've highlighted resources for decision support for traders. One longstanding resource that I've relied upon is Decision Point. The site has the largest collection of indicator charts that I've encountered, with superior coverage of sectors and individual indexes. Flipping through the charts at the end of the week provides an excellent orientation to the market's larger picture.

Above, I've taken sector data from Decision Point and charted them in Excel to show how the stocks within each sector are trading relative to their 20-day exponential moving averages.

As noted during the past week, we've been in a multiday trading range. Such range environments are created when sector rotation becomes a greater source of movement than directional index movement. In other words, institutional investors aren't so much pulling money out of stocks or putting cash into them as reallocating their existing holdings.

From the chart above, we can see that energy shares have been the great beneficiary of this reallocation, with formerly strong materials stocks now the laggards of the S&P 500 sectors. We can also see that consumer and industrial shares have also seen favor, responding to improving economic news.

At a broader level, we have 53% of S&P 500 large cap issues trading above their 20-day EMAs, but only 36% of S&P 600 small caps. It may well be that larger international companies that benefit from overseas sales are beginning to take the lead from companies less likely to benefit from a falling U.S. dollar.
.

The FDIC closed seven more banks on Friday, and that brings the total FDIC bank failures to 106 in 2009. The following graph shows bank failures by week in 2009.

Click on graph for larger image in new window.

Note: Week 1 on graph ends Jan 9th.

After a busy summer, the FDIC slowed down in late September and early October with only five bank failures in four weeks. Perhaps the pace is about to pick up again. With 10 weeks to go, it seems 130 or so bank failures is likely this year.

The 2nd graph covers the entire FDIC period (annually since 1934).

This is the most failures per year since 1992 (181 failures).

As far as failures per week - there were 28 weeks during the S&L crisis when regulators closed 10 or more banks, and the peak was April 20, 1989 with 60 bank closures (there were 7 separate weeks with more than 30 closures in the late '80s and early '90s).

For a graph that includes the 1920s and early '30s (before the FDIC was enacted) see the 3rd graph here.

Of course the number of banks isn't the only measure. Many banks today have more branches, and far more assets and deposits. Also the cumulative estimated losses for the DIF, since early 2007, is now about $45 billion.

And a message from Sheila Bair:



The FDIC era source data is here - including by assets (in most cases) - under Failures and Assistance Transactions

The pre-FDIC data is here.

“They are the more than half of all Americans who work at a small business, or own a small business. And they embody the spirit of possibility, the relentless work ethic, and the hope for something better that is at the heart of the American Dream.”

“Small businesses have always been the engine of our economy – creating 65 percent of all new jobs over the past decade and a half – and they must be at the forefront of our recovery. That’s why the Recovery Act was designed to help small businesses expand and create jobs.”

“It’s time for those banks to fulfill their responsibility to help ensure a wider recovery, a more secure system, and more broadly shared prosperity. And we’re going to take every appropriate step to encourage them to meet those responsibilities. Because if it’s one thing we’ve learned, it’s that here in America, we rise and fall together. Our economy as a whole can’t move ahead if small businesses and the middle class continue to fall behind.”

“This country was built by dreamers. They’re the workers who took a chance on their desire to be their own boss.  The part-time inventors who became the fulltime entrepreneurs. The men and women who have helped build the American middle class, keeping alive that most American of ideals – that all things are possible for all people, and we’re limited only by the size of our dreams and our willingness to work for them. We need to do everything we can to ensure that they can keep taking those risks, acting on those dreams, and building the enterprises that fuel our economy and make us who we are.”

“Thanks.”

Highlights, quips and quotes provided by President Obama.  The full script can be accessed via transcript or streaming video vis-à-vis www.whitehouse.gov.

While like many things said and promised, it sounds good.  But the harsh realities are- while the American ethic may run on small businesses, Main Street; policy has proven it’s a lot easier to ignite the engines that run the American markets and global status as a viable place to invest albeit at a very weak and falling denomination- Wall Street.   However true, weak, false or wrong that may be.

Show of hands- who do you think, besides banks- can help the little man?  The American Dream?  Who?  What?  Because I didn’t hear any real answers.  Just more stories to meet a political agenda.   

The Best of Times October 23, 2009 By John Mauldin >

It’s The Best of Times The Elements of Deflation It’s More Than Half Full Argentina, Brazil, and Uruguay

> What’s a Fed to do? We get talk about tightening and taking away the easy credit, but we got the fourth largest monetization on record last week. This week we examine the elements of deflation, look at some banking statistics that are not optimistic, and then I write a reply to my great friend Bill Bonner about why it’s the best of times to be young. I think you will get a few thought-provoking ideas here and there. But before we get to the main letter, I want to recommend a book to you. I am on a 17-day, 12-city speaking tour. It is rather brutal, but I did it to myself. However, one of the upsides of traveling is that I get quiet time on airplanes to read books. I am working my way through a very large stack of books on my desk. One that caught my eye – and I’m glad it did – is a book by Tom Hayes called Jump Point: How Network Culture is Revolutionizing Business. Hayes writes about how we are getting ready to experience a cultural change every bit as profound as the Industrial Revolution. He argues that as the 3 billionth person gets online sometime in 2011, it will shift the dynamic of how we interact as businesses and consumers. We get to 5 billion by 2015. The mind boggles. Clearly, it is already changing things, and I am not sure if I buy Hayes’ thesis that 3 billion is a magical number, though it is great marketing. That being said, I found something on almost every page that I underlined or highlighted. This book made me think about the future in ways that my kids already get but Dad doesn’t. I like to read books about “important stuff” by people who have done a lot of thinking about their subjects, and who can write easily and fluidly and communicate their thoughts without weighing me down with unnecessary verbiage. Hayes has done that. (I am sure some of you, my patient readers, wish I could be better at that!) No long review here. Go to Amazon and read the reviews. One writer wrote: “I gave the book 5 stars not because it was perfect — I think Hayes’s enthusiasm sometimes makes him jump to conclusions – but because there are so many ideas and observations here that it would take ages to put something like this together from other sources.” I agree. If you are in business, any business, you need to read this. As an aside, I will insist that all my partners worldwide get this book and read it. You can go to Amazon.com and buy the book. And Tom, if you get this (and I bet one of your friends will forward it to you), call me.

The Elements of Deflation

One of the advantages of travel is that it gives you time away from the tyranny of the computer to think. (Am I the only one who feels like I am drinking information through a fire hose?) But getting the information is important too, as it gives you something to think about. And I have been thinking a lot lately about deflation. I get asked at almost every venue where I stop, whether I think we will see inflation, or deflation. And I answer, “Yes.” And I am not trying to be funny. I think the primary forces in the developed world now are deflationary. When asked if I don’t think that the Fed monetizing debt of all kinds won’t eventually be inflationary, I answer, “We better hope so!” Let’s quickly summarize some of the ideas from the last few months of this letter. Just as water is made up of two parts hydrogen to one part oxygen, so deflation has its own elemental structure. The first element is Rising Unemployment. There has never been a sustained inflationary period without wage inflation. Wages are basically flat and falling. With 9.8% unemployment, 7% underemployed (temporary), and another 3-4% off the radar screen because they are so discouraged they are not even looking for jobs, and thus are not counted as unemployed (who made up these rules?), it is hard to see how wage inflation is in our near future. Think about this. Only a few years ago, less than 1 in 16 Americans was unemployed or underemployed. Today it is 1 in 5. That is a staggering, overwhelming statistic. Mind-numbing. Keynes said that you should stimulate the economy in recessions in order to bring back consumer spending. That is not going to happen this time. As my friends at GaveKal point out, this time we will have to have an Austrian (economic) recovery, or a business-spending recovery. My argument will be, when I am with them in Dallas in December at their conference, “Where are we going to get business-investment spending when banks aren’t lending and capacity utilization is at an all-time low?” This, of course, leads the Keynesians to jump in and say, “The government has to step up and jump-start consumption!” Which means more debt. Wash. Rinse. Repeat. The next element of deflation is massive Wealth Destruction. Two bear markets and a housing market collapse have put the American consumer on the ropes. And the next bear market will bring him to the canvas. Then we have Reduced Borrowing and Lending, as consumers are paying down debt and banks are reducing their lending. Both are necessary in a credit crisis-caused recession. Bank lending is basically back to where it was two years ago, and shows no sign off rebounding. Banks, as I have written, are buying US government debt in an effort to shore up their balance sheets. Lending to small business, the real engine of job creation, is sadly decreasing each month. (See graph below.) Next up in our elemental list we have Decreased Final Demand and its counterpart Increased Savings. Although the savings rate has come back down to 3% from 6% a few months ago, almost every expectation is that it will rise over the next 3-5 years back up to the 9% level where it was only 20 years ago. The psyche of the American consumer has been permanently seared. Consumption and savings habits are being changed as I write. And of course we must address the element of Low Capacity Utilization. While capacity utilization is rebounding, it is still lower than at any time since the data has been collected, other than the last few months. It is hard to see where businesses are going to get pricing power, when not only US but world capacity utilization is still extremely low. The chart below is not the stuff that inflation is made of. And let’s just quickly throw in Massive Deleveraging and $2 trillion in Bank Losses and a Very Weak Housing Market. Which brings us to a Slowing Velocity of Money. As I have written on several occasions, prices are a function of the amount of money times the velocity of money. If the velocity of money is slowing, the amount of money can rise without bringing about inflation. It is a delicate balance, but nonetheless the hyperventilation in some circles about the coming hyperinflation is, well, overinflated. Simplistic. Economically naive. The Fed is going to do what it takes to bring about inflation (in my opinion). But they will not monetize US government debt beyond what they have already agreed to. If they need to “print money” to fight deflation, they can buy mortgage or credit-card or other forms of private debt, which have the convenience of being self-liquidating. Read the speeches of the Fed presidents and governors. I can’t imagine these people will recklessly monetize US debt. You don’t get to their level without having a stiff backbone. (Yes, I know the gold bugs will call me terminally naive. We will have to wait to see who is right. Peter Schiff, care to make a bet on this one?) Bernanke warned Congress again last week about rising deficits. Watch the deficit rhetoric coming from the Fed after the next two governors are appointed next year, side by side with Bernanke’s reappointment. There will be a line drawn in the sand. Some in Congress will not be happy, but my bet is that the Fed will maintain its independence. If they do not, then my recent letters will prove far too optimistic (and many of you protest my rather less-than-positive suggestion of a double-dip recession). But I must admit I cannot imagine that happening. And there are not enough votes in Congress to change that independent status. There is a day of reckoning coming with the US debt. And thank God for that. Bottom line: The Fed will do what it takes to keep us from deflation. They will deal with the problems of the ensuing inflation. I wrote six years ago that the best outcome from all the easy monetary policy and budget deficits would be stagflation. I see no need to change that assessment. I am not happy with stagflation, but as I came into my young adult life in the ’70s (see below), I know that we can deal with that. The far more worrisome prospect is continued trillion-dollar deficits.

It’s the Best of Times

Now let’s change the topic. My friend Bill Bonner, of Daily Reckoning and Agora Publishing fame, recently wrote about his mother. Bill also turned 60 recently. I wrote to him about the similarities between our mothers. Both were born in hard circumstances, on farms that had no indoor plumbing. They joined the WACs and met their husbands. They struggled raising families. Bill and I both grew up in rather humble circumstances (to put a mild spin on it). That exchange caused Bill to write about the future our kids face. He has six kids and I have seven. He has graciously allowed all my kids to invade his chateau in rural France (where they mingle with his kids), and has invited us back next summer. I think Bill is the best writer, the best “turner of a phrase,” in the business. I often feel like a house painter standing in front of a Rembrandt when I read his work. But Bill is a tad pessimistic. He makes me look like Larry Kudlow. He wrote (among other books) Financial Reckoning Day, which has just been updated and is now titled Financial Reckoning Day Fallout: Surviving Today’s Global Depression. It makes for some interesting reading. Get it with Jump Point. Now to the point. As I said, Bill wrote about the future our kids face. I will repeat what he said and then respond. Bill’s thoughts: “We sat in a cab yesterday, stuck in traffic in central London. We watched people walk by and wondered. What are they thinking about? What do they want out of life? What do they think of themselves? “There were hundreds of them…different shapes…different sizes. A businessman in a pin-striped suit, briefcase in hand, concentrating on his sales report; he almost stepped in front of a motorcycle. A salesgirl, grotesquely overweight…yellow hair streaked with brown…wishing she hadn’t had so much to drink the night before. A lawyer daydreaming about his secretary. A man who would have rather been fishing…still in his waxed coat. A woman annoyed about something. A heavy construction worker, his legs splayed outward as he walked. A tense young woman who dared not look up. A woman worrying about her son. A man thinking about buying a new car. One man trying to remember a line from a song he learned 30 years ago. Another talking to herself. One looked like a doctor taking an afternoon stroll. Another was stark raving mad. “All of them walking along…from one place to another…shuffling along…the living towards the dead. “We were thinking of our children. What a different world they grow up in. And yet, it is still the same too. A man might have been stuck on a London street 50 years ago…and hundreds of years ago he might have watched the same shopkeepers and carpenters walk by, each caught in his own thoughts like a fly in a spider’s web. “Our old friend John Mauldin wrote to say that his mother’s experience was not much different than ours. She joined the WACs during the war…met John’s father…and then nature took her course. “But both John and your editor had a big advantage in life. We both caught the upswing. “Not so with our children. They inherit a different world. America was the world’s leading nation in the ’50s and ’60s. And it was growing in power and wealth – rapidly. We grew up with it. Things were getting better and better…we were sure we’d live much grander, richer, and more exciting lives than our parents. The sky was always the limit! “Now, America is in decline. China’s economy grows while hers declines. The Far East has savings, while she has none. The Asia nations are net exporters, making huge profits…while American industries are judged too old, too expensive, and too highly regulated to compete. Americans have debt up the kazoo, while their competitors have little. A young person in America has to look forward to supporting 70 million retired baby boomers…and paying for their drugs, their food, their wars, and their bailouts. “For our children – ours and John’s – the situation on a personal level is different too. Coming from poor families, we could look forward to much more wealth and material success than our parents ever knew. “We came back to Ireland this week for a reason that our parents would never have dreamed of. Your editor has set up a family office. It is a very modest affair by family office standards. The typical family office manages a fortune of $100 million, according to . We may not even be on the same planet with these rich families; but we are in the same universe. That is, we try to think about…and manage…our wealth as rich people do…as a family legacy or an endowment, not as a retirement fund. “What wealth we have accumulated – even if it is paltry – will be held by a family-owned corporation. Then, the corporation, run largely by the adult children, manages the assets – from our base in Ireland. “Your editor, freed from the responsibility of managing his own money, will be free to wander and think…like a vagabond, a gypsy, a refugee, an itinerant mendicant…forced to sup on whatever is at hand and take lodging wherever he can find it – but favoring the Four Seasons and Chateau Margot when they are available. “Whatever else this does, it puts the children in a very different situation from their parents. Instead of starting out with nothing, they’re starting out with something. While this would seem to be a big advantage to them, it has huge hidden disadvantages. Like America itself, they are in danger of finding themselves slipping downhill. Instead of expecting things to get better, they may find it hard even to hold onto what they’ve got. Instead of the “Morning in America” that Ronald Reagan promised, they may find that it seems more like evening, both in their personal as well as their national lives. “‘From shirtsleeves to shirtsleeves in three generations,’ say the French. The grandfather begins without a coat. His grandson ends that way. “But what to do? Spend it all now…so the children begin with the same clean slate we had? Move to Brazil or India – countries with more obvious upside? “In the deep, cosmic end, it probably doesn’t matter. The advantage to starting out on an upper rung of the ladder may be about equal to the disadvantage of having to worry about falling off. Who can know? “Every man has to play the cards he’s been dealt. What else can he do? He may have a humpback or a beautiful voice. He may have had a hard upbringing or a soft head. He may have a fortune worth of poetry in his soul but not a dime in his pocket. As far as we can tell, every young man starts out even. Each one begins life in the same place – where he is. And every generation takes what it is given, and makes the best of it. “The real advantage in life is having the gumption to get on with it; no one knows where that comes from.”

It’s More Than Half Full

Ok, Bill, let’s review those wonderful days from whence we sprang, so fraught with the advantages of having nothing. So potent with opportunity. It was the middle of the ’70s when we started our careers. Inflation was high and rising. The Soviets were seen as a major threat. Japan was beating our brains out and buying everything, even if nailed down (like Pebble Beach and New York skyscrapers). I had to borrow money at 15% (or more) to buy paper in order to meet customer demands for printing. And guess what? The banks got into trouble and called loans willy-nilly. (My bank even called my mother and threatened her to pay off my loan – against written agreements – and she did. Evil sons of bitches. The more things change… And that bank did fail, I report delightedly! Not that I hold a grudge.) There were multiple successive and ever-deeper recessions. Gold was rising and the dollar was seen as a joke. Howard Ruff (a good friend to both of us when we were starting out!) and almost every newsletter writer were telling people to buy gold and freeze-dried food to protect themselves against a near-certain economic, if not apocalyptic, catastrophe. Unemployment was high and rising for a decade. The correct answer to the question, “Where will the jobs come from?” back then was, “I don’t know, but they will.” And that is the correct answer today. In 20 years, no one will want to come back to the halcyon days of 2005. Our kids (all 13 of them) are getting ready to live through what will be the most exciting period in human history. There will be a century’s worth of change, measured by the standard of the 20th century, just in the next ten years, and then we will double that pace in the next ten after that. Medical miracles will mean our kids and grandkids will live a lot longer than their dads, although I intend to be writing well into my 80s, like our mutual hero Richard Russell. There will be whole new industries developed in the US. How do I know that? Follow the money. The rest of the world spends a fraction of what we do on research and development. Where do you go if you are looking for venture capital? Do I care if the Chinese and the “developing” world are far better off, relatively speaking, than the US in 20 years? Not a whit. Good on them. I hope they make discoveries and inventions and grow new businesses that benefit us all. But we are not going into some long dark night. We, and our kids, get to choose how we respond to what is the reality of the day. Our nation had to almost hit the wall in 1980 before a Volker could come along and force us to take the pain of recession to beat back inflation. And we will have to come perilously close to the wall this time before we take action as a nation. Way too close for comfort. Maybe you are right, and we have a soft depression. I hope not; but even so, the world will be better, far better, in 20 years, with far more opportunities than today. It was not fun starting new businesses in the ’70s and early ’80s. But we did. I remember coming to Baltimore and being (literally) afraid to get out of the car to visit your offices in the slums. But that was what you could afford. A far cry from the chateau in Ouzilly. I lived in a small mobile home. Tiffani was born there, and we converted part of the kitchen to be her bedroom. (Yes, I was white “trailer trash.”) But I got up every morning just like you did and killed as many alligators as I could. The rest had to wait ’til the next day. And that is the legacy our kids have. They know what it is to wade into the swamp every morning. Never quitting. In thinking about this, you may be the father I respect the most. You have raised your kids to be multilingual children of the world. What a work ethic. How did you get them to scrape window shutters at your chateaus? (I actually saw this, and my kids marveled. Thereafter I threatened to make them go live with you when they didn’t behave!) You have given your kids the opportunity to follow their dreams, even demanded that they do so. And such dreams they (and mine) have. Will they succeed? Who knows? But they will go at it with gusto, in a world with more opportunities than you and I ever imagined 40 years ago. And, oh boy, were we optimists back then. How else could we have done what we did? If we believed the rhetoric that the world was coming to an end, would we have dared to venture out? You cannot have raised your kids to be such bold adventurers without instilling in them a certain high level of optimism. I am going to out you, Mr. Bonner. You present yourself to your readers as a bona fide end-of-the-world pessimist. But you are a really and truly a closet optimist. Your whole business empire (and what an empire it has become!) is based on finding people who are optimists, in the sense that they think they can actually get people to send them money for what they write. Which they do! Even if it is to read why the world will come to an end, which thankfully it never does. You are right in this: it is personal gumption that makes or breaks us. There are those who started out with less than we did (hard to imagine but true) and made a lot more. And there are those who started out with far more and made less. But there are very few who are happier than either of us. Or luckier. Our kids? It is not the times that dictate the man (or daughter!), but the response of the man which dictates his own time. Today promises a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it. And as our kids do just that, and as the millions of kids of those who read us do so, and the billions of kids who are just now getting ready to bust loose all work to achieve their dreams, the world is going to be a far more fantastic place. Smooth ride? Not a chance. We didn’t get one; and in thinking through history, there have not been many smooth rides. Why should we think that will get any better? Our kids will just have to live with our generational (and individual) iniquities, government debt and all, and figure out how to master their own fates. But if I had a choice to take the ’70s or today? In less than a heartbeat I would choose today. And I bet you would too! (Side note: You can subscribe to the Daily Reckoning and read more of Bill’s great prose. Warning: it is bearish, but lively and fun.

Argentina, Brazil, and Uruguay

Tonight I am in Orlando, where I spoke at the Commonwealth national conference. I have been to a few conferences here and there, but I must admit to being impressed. A conference for brokers and advisors who are affiliated with them, it was exceptionally well done. And a very smart crowd. These guys have attracted some exceptional talent. Tomorrow morning I fly back to Dallas, where I get to see my new grandson, Hayden, for the first time. Born this week a little early while I am on the road, I get a call at 3 am on Monday telling me the news and sending me a picture. Wow. The heck with deficits and deflation. How can you not be an optimist? Then later in the afternoon I am off for Argentina, Brazil, and Uruguay, speaking in four cities and meeting with clients (and future clients) of my Latin American partner, Enrique Flynn. And then back to Philadelphia, again in Orlando, Scottsdale, and one trip to New York in early December. Then not much else is scheduled – but past performance says that will change. There is a steak and a bottle of wine waiting for me down the hall, so it is time to hit the send button. Have a great week. I know I am. I love South America, and look forward to coming back to you with my impressions. Your wondering who made up this schedule analyst, John Mauldin John@frontlinethoughts.comCopyright 2009 John Mauldin. All Rights Reserved If you would like to reproduce any of John Mauldin’s E-Letters you must include the source of your quote and an email address (John@FrontlineThoughts.com) Please write to info@FrontlineThoughts.com and inform us of any reproductions. Please include where and when the copy will be reproduced.

From GMU economist Donald Boudreaux.

From GMU economist Donald Boudreaux.

Following my rant about the putzes at the NAR, a few people asked me to better explain the Seasonality Adjustment issues.

Here goes nuthin:

I certainly understand that we have to do seasonal adjustments. One cannot report that Retail Sales fell 80% in January (for obvious reasons) but most of all, because to do so would be misleading. The sources of data report information to inform the public, media repeats what is said, and we pass along interpretations to make things clearer, to get at an objective truth.

The NAR does the opposite.

Let’s look at the specifics of the adjustments this year and see where they went awry.

Whenever we have an outlier year — like Sept 2009 — then we know that seasonally adjusted results will be utterly misleading. That is an issue when we seasonally adjust, as every statistician, economist and number cruncher is well aware.  An honest broker of information recognizes that, and reports it the data in a way that is not misleading.

The NAR is no such honest broker (pun intended).

Most people are unfamiliar with what goes into the methodology of Seasonal adjustments, and how they are performed. When people misunderstand statistical methods, it allows folks like the NAR to make major misrepresentations, and get away with their misrepresentations. It is incumbent on the people who are “numerate” — who understand mathematics — to explain it.

There is a mathematical assumption in SA that the annual seasonal changes will occur around the same time each year. There is also a presumption that the month-to-month changes will be approximately equal, or at least of similar magnitude, from season to season. This forms the baseline for the seasonal adjustment.

Hence, when we are discussing EHS, the prior years’ monthly August-to-September drops are the basis for making the newest seasonality adjustment.

As Rex pointed out, the past decade of August to September EHS changes were:

1999: -19%
2000 -17.7%
2001 -26%
2002 -17.1%
2003 -12.5%
2004 -15.5%
2005 -15.2%
2006 -19.2
2007 -28.9%
2008 -10%

This range was 10% to 28.9%. That averages to 17.2% in the typical September. This is the key element in impacting any subsequent seasonal adjustment (different SA methodologies may use differing time periods).

This year, the fall was 5.3%. Hmmm, that was highly aberrational — I wonder why?  We (and the NAR) know the reason: Due to ZIRP and the soon to be expiring 1st time home buyers $8,000 Tax credit, the drop was minor – much smaller than it usually is when we go from August to September in EHS.

The tax credit very likely extended the selling season by at least a month. It pulled some sales forward, and perhaps created other sales where there might not have been.

But the seasonal adjustment does not know that; The math PRESUMES THE AUGUST/SEPTEMBER DECLINE IS OF TYPICAL MAGNITUDE OF THE PRIOR 10 YEARS.

That creates a misleading — lets even say false — appearance when the seasonally adjustments are performed.

Again, someone trying NOT to mislead will inform the reader of that directly. But calling it a SURGE?  Only if you are innumerate — or a liar. Any honest statistician who worked on these numbers KNOWS that the seasonal adjustment was going to create a big bump, a misleading number, based on the historical data.

And thats the whole point. The NAR knows that calling this a surge will mislead readers, but they report the data — DOWN 5.3% — as a  “SURGE.”  What else might their goal be BUT TO MISLEAD THE PUBLIC?

I refuse to facilitate that. And I will call anyone an unprofessional liar, a distorter of the data who claims this was surge. THIS MEANS YOU, NAR !

The folks who are unfamiliar with seasonal adjustments will get caught in the scam. This was not an ordinary seasonal adjustment — it was highly misrepresentative.

I know better. And now, you know better. Unfortunately, most folks do not.

rdan

Reader donald sent this note for consideration:

Sunday night while slogging back up to Burlington from Hartford, CT (460 miles round trip as it turns out) we were listening to NPR. I didn't think to make a note of what show, but it was discussing health care and brought up a point I wasn't aware of that explains a lot of the rational part of the current controversy.

The story is that a decade ago Aetna was in trouble in the health insurance field. They returned to profitability not by greater efficiency or any of the other things one might expect, but by dumping hundreds of thousands of customers in markets where they were weak relative to other providers.

Why would showing customers the door be a money making move? Because insurance companies negotiate rates with providers, and the bigger the company in any given market, the more clout it has to negotiate lower rates. Costs are shifted to weaker players in the local market and to their customers.

I think this explains one reason why the health insurance companies fear a government option. The government would likely be a strong player in many (most) markets, and will negotiate good deals. Costs will be shifted to the health insurance companies by the free marketplace with no subsidies of other unfair competitive tactics. The insurance companies are not afraid of unfair competition exactly. They are afraid of being "Walmarted"

Is there a way to avoid this? The NPR program claims there is. According to them Maryland sets the price for all medical procedures so that all insurance companies are reimbursed at the same rate for the same procedure. That (purportedly) means that health insurance companies in Maryland have a leveller playing field than the rest of the country and have to compete on the basis of factors other than the deals they can negotiate with healthcare providers.

I believe that similar practices exist in countries with health care systems that actually work. Perhaps we should consider something similar nationwide in the US.