Citi, banks, stress tests – I’m confused

Healthcare – This is important!!

Obama keeps going on healthcare

The New Rules of War

Geopolitics…

I feel left out of the gravy train…

To Whom Does The Fed Intend To Sell Its MBS? Great title from The Atlantic Journal, but I had to respond

This story was definitely under-reported: A must read from the Financial Times.

TARP overseer says bank bailout program has mixed results

Why is this story going by with no reaction? I have to admit that often, some news stories are so obvious and out there, that I don’t bother to post them because it feels like they’re already plastered all over the place. I assumed this was one of those stories that would be all over the blogosphere, newswires, etc. And yet, I haven’t found a lot of reactions (or at least as many as I’d expected).

Here’s the quote that summarizes it all for me:

…”Stated another way, even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car,” said the report…

Read the full article here:

http://www.marketwatch.com/story/overseer-bank-bailout-program-has-mixed-results-2010-01-31

The report goes on to criticize TARP for not stimulating lending, failing on the mortgage modification front, and most importantly, continuing to distort the asset markets, specifically housing!! So a government report comes out, criticizes a program that is going to be expanded for not achieving its stated goals, then goes on to state that the entire program is distorting prices and may yet lead to another asset bubble!?!?! Why are people not reacting to this? Is it so obvious that they’ve already priced it into the markets? I don’t think so. In fact, I think no one wants to listen. But the bond market will start listening soon (first). As Fannie and Freddie continue to hold up the housing market, we can only continue the charade for so long. Look for 10-year yields to break through 4% in the upcoming months.

Interestingly, Wells Fargo might have just gotten our vote of confidence, by being on the other side of the carry trade and sacrificing gobs of money (very scientific) to take off risk. What does it say about the other banks? http://www.bloomberg.com/apps/news?pid=20601109&sid=aM.IPx7G5hAw&pos=13

Is Oregon a sign of things to come?

From the wsj.com:

…Oregon voters approved two special tax measures Tuesday designed to close a $733 million state budget gap. With 91% of the vote counted, Measure 66 garnered 54% of ballots and Measure 67 received 53%, the Associated Press reported…

…Measure 66 increases Oregon’s personal-income-tax rate by two percentage points for households earning over $250,000 a year. Measure 67 calls for an increase in the state’s minimum corporate income tax, currently $10 a year, and imposes a tax on gross revenues for corporations that don’t report a profit.

…”Passage of these measures means we keep core services of education, health care and public safety that Oregon families, businesses, and communities count on,” said Oregon House Speaker Dave Hunt, a Democrat who represents Clackamas County. Defeat, he said, would have forced the state to cut nearly a billion dollars more from such services.

The twin ballot measures also served as a gauge of anti-business populism and highlighted a nationwide debate over whether to fix state budgets by targeting the affluent. But they also fueled resentment of “tax and spend” legislators, as well as public-employee unions whose members enjoy job security at a time when thousands here have lost jobs.

http://online.wsj.com/article/SB10001424052748704094304575028951284541726.html?mod=WSJ_hps_MIDDLEThirdNews

Is deflation winning out?

In the ongoing debate between inflation and deflation, we’ve heard both sides, tried to look to the historical record for guidance, sought comfort from statistics and experts, yet in the end have come up with strong arguments on all sides. We’re not even sure all the information is conflicting anymore, but in the end, we have to define and quantify a bias, a world view, a story that binds the different pieces together. We find ourselves continually biased towards deflation. It’s colored our decisions, and impacted our investments, and still we find ourselves now with seemingly conflicting investing ideas: short bonds and long metals sounds like it might be inflationary trades, underweight equity and long cash sound like they are deflationary trades. Underweight real estate, overweight India and zero weight to China – how do those all fit in? Are they hedges against each other? Compounding each other?

Let’s start with some basics. Deflation happens when an organization loses pricing power. It happens when organizations need to find lower market clearing prices. It can happen in positive ways (for example, by paying $500 for a laptop with the computing power that cost $5,000 a few short years ago) or negative ways (for example, when you’re house sells for 15% less than it did 3 years ago). It is initially painful to the seller, and especially painful to the levered seller. For the buyer, it feels great – initially. Until it doesn’t. At some point, the buyer decides that it’s worthwhile to wait longer for an even better deal. At some point after that, the buyer realizes that whatever product of service he/she is selling will probably also need to be discounted in order to clear, at which point a bit of fear sets in. And there’s the danger. On a more macro level – organizations that lose pricing power face a squeeze on margins. Those that are levered then face a squeeze on financing. On a more macro level – trade goes down, protectionism looks like a good idea, and then it’s over. At some point market clearing prices are reached, companies that survive with strong balance sheets regain pricing power, etc.

Why go through this exercise? Let’s think through the organizations we have to analyze: people, households, companies, governments. As we go through each organization, we find deflationary forces:

1. People – labor is not in control these days. Wages are stagnant, at best. Unemployment is at 10% and if you’re using good statistics, closer to 18%. If anything, wages will be put under pressure in the near future.
2. Households – continue to be indebted, even though many are trying to lower it. Residential real estate has been nationalized, with 95% of new mortgage originations occurring through GSE’s. Real estate has not stabilized, and commercial real estate is about to roll over.
3. Companies – retails has actually held up better than expected, but credit card defaults are rising and the consumer will require more and more sales (deflation) to purchase. Internal demand from Asia hasn’t materialize (yet). Most importantly, margins have risen to such high levels off the back of squeezing costs. Margins going forward will be tough without an increase in revenues, which hasn’t come.
4. Governments – governments can lose pricing power as well. Japan has been a startling anomaly, but I wouldn’t depend on it continuing or working for others. With debt to GDP starting to hit important levels, government bonds will lose their appeal, and with it, their pricing power. So, prices will have to go on sale. We’re seeing it already in the municipal bond market. We’re seeing it with sovereigns like Greece. We’ll see it with Treasuries as well. If the US government loses pricing power, won’t the dollar fall as well? Actually, it might not. The dollar will still be needed for trade, for a safe haven, and as a relative trade against the worse government situations in Japan and Europe, so we can have a situation where the dollar is up and the Treasuries are down.

All of these organizations seem to me to point to a contraction of margins on all fronts, loss of pricing power, consolidation, retrenchment, and balance sheet rewinds to the pre-”stock option/insanely low interest rate/agency-moral hazard games of manager vs. owner/etc.” times.

We continue to mistrust rallies at these valuations, and are wary of people screaming to buy the dips.

The beginning of the end?

I don’t know, but it has to come at some point. The main thing to watch here is not earnings, not Bernanke, and not your statements. The main thing to watch is the bond market. Bonds are holding relatively stable, 10 yr yield is even slightly down. What does this tell us? For starters, it tells us that the money being pulled out is not being directly put into long Treasuries. We’ll know in the next few days if it goes there to park, but why go long in this environment? All along, we’ve been saying the market might go up, but the fundamentals suggest otherwise. We continue to see downside risk across asset classes.

We’re holding our large cash positions and not putting it to work here. Maintaining position in the metals, but it’s a small portion of our portfolios, but it’s been getting hurt the past couple of days. Long term, we continue to believe a small allocation is appropriate. We have been conditioned to buy the dips, but it doesn’t work if the fundamentals are against us. Maybe in the short term, but…

Now, back to this Bernanke thing. This might be the first time in history that a Fed chairman isn’t reconfirmed. Poor Ben. The politicians who are more responsible than him, like all the senators who for years accepted kickbacks from Fannie and Freddie, are trying to use him as a scapegoat. Let’s see if Obama can save him. If not, it will be another blow for Obama & Co.

Obama & Co. are scrambling: Banks and political games

So Mass. went to the Republican candidate, for the first time in 40 odd years. Brown won Ted Kennedy’s seat and in the process upset Obama’s drive for healthcare reform. Pelosi and Obama will probably not be able to push through any legislation in the next couple of week, so it means that we’re now in a holding pattern. Turns out markets tend to do better when governments are gridlocked, mostly because politicians can’t do as much damage.

So now that he’s been stymied on one end, Obama has to show progress on another, so back comes Volcker. He was marginalized, but now is being made the poster boy in high-stakes political game that might leave Geithner and Bernanke in trouble. The Democrats were sent a message in Mass. and they need to scramble. Bernanke might be made the whipping boy, although Geithner is scared too.

So where does that leave us? In limbo-land. Banking regulations will re-instate some form of Glass-Steagall. They have to. The public is angry that tax payers money went into the pockets of executives and the risk taking behavior is back with a vengeance. So the big banks ROE will be even worse going forward and stocks need to reflect the uncertainty, so for now, why speculate? Not worth it.

On another note, I think all of this posturing, and all these announcements and speeches, and all of these Geithner vs. Volcker games, all of it is part of a game of obfuscation. We are being toyed with, and once again, the issue is government entities. Before Christmas, we wrote that Congress passed (hoping to be unnoticed) legislation that provided more funding to Fannie and Freddie. Now, Fannie and Freddie need to be put on the Fed’s books, increasing the government’s liabilities by a few billion dollars, and no politician wants to be the one to say it and bring it to light. So they’re playing a game of diverting our attention. In reality, Fannie and Freddie are already liabilities of the Fed, but they aren’t being counted. Bringing them onto the Fed’s balance sheet will balloon liabilities and make the government more than the lender of last resort. It will make the Fed responsible for mortgages and servicing. Do you really think politicians will allow Fannie and Freddie to foreclose on homeowners? How will their debt be serviced? Only two options: printing or taxing, since repossessions will be impossible. End game: I don’t even want to theorize, but I’m not a big fan of the GSE bonds.

In a related note, the Swiss are flexing their muscles and standing up to US disclosure requirements. Translation: the rich will still be able to shield money away from the hands of Uncle Sam. Expect to see more assets move offshore if taxes go up. Law of unintended consequences.

China reigns in monetary policy…

and the world catches a cold. We wrote about this a few weeks ago, whereby the Fed’s fear of being 1937′ers is completely misguided given that China might thwart any efforts to re-inflate. We are no longer living in a world where domestic monetary policy is sufficient. Interestingly enough, for you gold bugs out there, it is a better argument than historically for using physicals (gold being the most prominent) as the reserve currency. So China is telling banks to slow, or even halt, lending.

My main question is why now? Depending on your frame of reference…

If you believe the Chinese government is ahead of the curve, then China is reigning in inflationary pressures, making sure it’s banks are in strong shape, and this is a net benefit to China. Conversely, if you believe the Chinese command economy is not as strong as the numbers suggest, then this might be a sign that government officials are scrambling because the proverbial “stuff” is about to hit the fan, and they are scared. Guess what I think…

China needs a way to save face as it’s numbers start to come down quickly. If it’s part of a design, they might look smart. The growth stats are going to come down one way or the other, the only question is who will get blamed, which politicians will be lost along the way, and how the government squelches social unrest.

This is net positive for gold (although it doesn’t seem that way today), maybe USD (flight to safety?), and net negative at least in the short term for Asian block. Also, I think here a negative for China, might end up being a positive for India

The government may force the buying of Treasuries by retirement accounts

This article came out in BusinessWeek on January 8th, 2010. The gist of the article is that the government is looking for ways to structure 401K and IRA accounts as annuities, rather than letting investors choose their own investments. The hope is that retirees will get a defined income stream after a specified age or contribution. The thinking is that people often take lump sum payments out of retirement accounts or when they transition, instead of choosing lump sum payouts.

The criticisms, with my personal take, are the following: first, retirees already have an income stream from Social Security. That system has not proven itself as viable in the long term, why compound the liability on tax payers? second, defined benefit pension plans are part of the problem of legacy costs for industries such as autos, bringing them to bankruptcy, why would we want to expose the country to that liability as well? Third, annuities are not good at guarding against inflation, so let people control their own investments and invest in stocks, which tend to be more volatile, if they choose to. Fourth, what would be the appropriate investment to guarantee returns? Yup, TREASURIES! This is a roundabout way for the government to force investors to buy Treasuries and fund government liabilities. Long term only two outcomes are viable: either people will put less into accounts where they have to buy these securities and/or the people who do will lose money, not get the defined benefits they expect and tax payers will be on the hook.

Another one in a long line of governmental interference leading to gross mismanagement of our collective national interests. Read the full article here.