You could see this one coming given the humiliating circumstances under which the German Chancellor learned that GM was pulling out of the Magna deal.

The BBC is now reporting that Germany will give General Motors no aid to restructure it’s business. That’s 4.5 Billion Euros they now need to come up with.

Economy Minister Rainer Bruederle told GM executives that they had to be responsible for restructuring the unit.

Germany had previously offered 4.5bn euros ($6.7bn; £4.1bn) to support Opel and protect German jobs if the company was sold to car parts maker Magna.

On cancelling the sale last week, GM said it would still seek state aid.

The German minister’s comments now raise question marks over whether GM will get it.

"I expressed my expectation that General Motors should basically carry out the financing itself," Mr Bruederle said.

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Related posts:

• GM considers keeping Opel, raising capital
• Germans reject Chinese offer for Opel
• GM board decides to keep European Opel unit
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Economic nationalism and GM’s decision to keep Opel and Vauxhall

Tim Geithner has issued a Code Red on the U.S. dollar, but he doesn’t think Americans can handle it.

I believe deeply that it’s very important to the United States, to the economic health of the United States, that we maintain a strong dollar.

Secretary, I have just one more question. If you gave an order that the dollar wasn’t to be touched and your orders are always followed, then why would the dollar be in danger?

I want the truth!

You can’t handle the truth!

I have a greater responsibility than you can possibly fathom. You weep for the dollar, you curse the U.S. Government. You have that luxury. You have the luxury of not knowing what I know – that the dollar’s death, while tragic, probably saved lives. And, my existence, while grotesque and incomprehensible to you, saves lives.

I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide and then questions the manner in which I provide it.

Did you order the Code Red?

You’re goddamn right I did.

Source

Geithner Says Strong Dollar ‘Very Important’ to U.S. – Bloomberg

Happy Veterans’ Day (especially to my dad, uncles and aunt and all of those no longer with us)

Related posts:

• Geithner and Summers consolidate power
• The U.S. is exporting unemployment with ‘Buy America’
• Rosenberg: The U.S. dollar could be next
• The dollar is rising against floating currencies
• Best Buy and Wal-mart sued over typical Chinese knockoffs

Citigroup has been losing tens of billions of dollars over the past two years as the financial crisis has unfolded. They are clearly the weakest of the too-big-to-fail institutions in the United States. Earnings results this year demonstrate that their raw earnings power is no match for the likes of JPMorgan Chase or Wells Fargo. Moreover, their capital base has been impaired, causing them to have to sell assets, reducing their earnings power further still.

Unless something miraculous happens over the next few years, they are not going back to the glory days of $20 billion yearly net income. That’s why their mountainous $38 billion deferred tax asset is a problem.

Reuters explains:

Citigroup has a roughly $38 billion deferred tax asset, which essentially represents expected cash flow from future tax benefits. Accounting expert Robert Willens said on a conference call late last month that he expects the bank to write the asset down by about $10 billion in the fourth quarter. That would represent about 7 percent of the bank’s net worth as measured by the reported value of the company’s shareholder equity.

What is going on here is a result of the fact that companies keep two sets of books – one for the taxman and one for public statements.  On the tax books, they pay fewer taxes upfront than we see in their public accounts (I know it sounds dodgy but I am sure a tax accountant can explain). By deferring the tax liability, companies reduce the net present value of the tax charges. Everybody wins except the taxman, right? 

Well, not exactly.  If Citigroup cannot make enough taxable income in future periods to cover these deferred tax assets, they are going to have to take a charge and write down the asset immediately. That is what Robert Willens is pointing to. If he is right, Citigroup would have $10 billion less capital as soon as Jan.1, 2010. And given they are perhaps the least well-capitalized of the stress test 19 except GMAC, that’s a problem.  It would certainly constrain their lending capacity.

But, of course, Citi officials have already come out to put any fears to rest.

"We are comfortable with the valuation," Kelly said, adding that the bank looks at its deferred tax asset at the end of each quarter. About $16 billion of the deferred tax asset must be realized by around 2016, and the rest has a much longer time frame, Kelly added.

Whew. For a second there, I was starting to think Citi needed another bailout.

By the way, Bank of America has a similar problem.  They have a huge net operating loss (NOL) carry-forward from their acquisitions of Merrill Lynch and Countrywide Financial. If BofA cannot make enough taxable income to use all of their NOLs which are now assets on their balance sheet, they too will have to take a ‘valuation allowance’ a.k.a a hit to earnings.  The net deferred tax liability at BofA (incl. NOLs) was $19.6 billion according to their 3Q 10-Q filing.  See the note below (click to expand).

As you would suspect, “The Corporation has concluded that no valuation allowance is required.”

Source

Bank of America SEC filings – BofA website

Related posts:

• JPMorgan has record revenue and $2.7 billion in profit
• Are Citi and BofA gaming the Geithner Plan already?
• Is Citi being forced to downsize by Obama?
• Merrill and Citi are the big losers this season
• Citigroup and Redecard: shedding international assets

You have probably heard the term money illusion.  I want to coin a related new term called unemployment rate illusion because I think it is significant in light of some of the things David Rosenberg said earlier today about the unemployment rate in the U.S.

Wikipedia’s definition of money illusion is good:

In economics, money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value (nominal value) of money is mistaken for its purchasing power (real value). This is a fallacy as modern fiat currencies have no inherent value and their real value is derived from their ability to be exchanged for goods and used for payment of taxes.

The key here is that behavior changes in accordance with the nominal numbers used as economic signposts in an economy. This is one reason why governments are often accused of manipulating their economic statistics in order to present a more regime-friendly face (see here and here).

The parallel of money illusion to unemployment rate illusion is that a higher posted rate of unemployment can have a serious negative impact on consumer confidence and personal consumption (think balance sheet recession). All else being equal, higher unemployment rates mean lower confidence and consumption. So, a lower unemployment rate is a better unemployment rate as far as incumbent politicians are concerned.

Now, you don’t have to be a conspiracy theorist and think that the government is deliberately suppressing the unemployment rate to understand what I am about to say. You just have to understand economic cycles in the context of the note from David Rosenberg today.

What I am talking about is the second paragraph of a quote I highlighted (bolding added):

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Let me put this quote in unemployment rate illusion terms:

• People pay attention to the posted U-3 rate of unemployment. Right now it is 10.2%, which is high.
• However, it could be much higher – 10.8% – because a lot of people aren’t getting counted. They are dropping out of the labor force and artificially suppressing the labor force participation rate. This will change when recovery takes hold as a better economy brings back those discouraged workers.
• It’s even worse than that because, U-6, the most comprehensive rate of unemployment is sky-high at 17.5% and much higher relative to the posted rate than is normal. Even if U-6 declines to 15-16.%, using a normal gap to the posted rate gets you a posted rate of 12-13%. Nothing has changed, discouraged workers have re-entered the labor force. It is unemployment rate illusion.
• If people see 12-13% in 2010, they will be floored, angry, and looking for someone to blame. As Democrats control Washington, they will get the lion’s share of the blame and lose big time in 2010.
• Making matters worse, this is the kind of shock that causes people to put their checkbooks away and go home for the night a.k.a sending us into a double dip recession.

This is a case where unemployment rate illusion is definitely not a good thing.

What to do? 

Well, if you’re the President, you have to under-promise and over-deliver. President Obama has been doing exactly the opposite. Of course people are going to be angry when you promise 8.0% unemployment and instead we get 10.2%. Right now, Obama should be talking about 13% unemployment.

Moreover, Obama needs to throw his weight around. He should be telling people publicly, “my policy team is telling me that if we don’t get what we want through Congress, this fragile and unsatisfactory recovery will crumble and we will see 13% unemployment or much worse. And it will be the Republicans fault that this happened.”

Then he should turn to the Republicans and say, “give me everything I want or the economy will crumble and I will make sure you get the blame.”  Remember, that’s what Hank Paulson did and it worked brilliantly (a 777-point implosion in the Dow helped). What is the Republicans’ BATNA (best alternative to a negotiated agreement)? Nothing.

If you’re a Republican you should continue on the same course. Obama shot himself in the foot in January and February by not taking the Hank Paulson approach. Now, you get to label him a ‘socialist’ or anything you want. And you get to tell people that stimulus is budget-busting pork designed for the Democrats’ union buddies that doesn’t work and bankrupts America. It’s been working so far. Given the fact employment is likely to rise to a post-Great Depression high, why wouldn’t you continue on the same path? Don’t fix what’s not broken.

…coming soon to a TV screen near you.

Related posts:

• Rosenberg: U.S. unemployment rate headed for 12.0-13.0%
• Comprehensive unemployment rate is 17.5%
• A note on government statistics and unemployment
• Unemployment: U-6 data versus the Great Depression
• Unemployment Report: biggest rise in rate in two decades

David Rosenberg thinks the unemployment rate is headed much higher than anyone anticipates.  If you recall, back in January when the stimulus package was crafted, the Obama Administration felt that passing the bill would mean an unemployment rate which would top out at 8.0%. As the situation deteriorated, the President recognized that 10.0% was more likely – a number we just got last week. But Rosenberg is the only one (except Meredith Whitney) who is talking about 12-13%.

As an aside, it was interesting to hear Whitney at about 3:15 into the third video in the link above from July. Right before she gives us the dreaded 13% number, she admits to lowballing her house price decline estimates in order not to be dismissed as wildly out of step with consensus. That pressure is something I discussed here.

Here’s what Rosenberg says:

There are serious structural issues undermining the U.S. labour market as companies continue to adjust their order books, production schedules and staffing requirements to a semi-permanently impaired credit backdrop. The bottom line is that the level of credit per unit of GDP is going to be much, much lower in the future than has been the case in the last two decades. While we may be getting close to a bottom in terms of employment, the jobless rate is very likely going to be climbing much further in the future due to the secular dynamics within the labour market.

But in a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

As I indicated when the employment numbers came out last week, we should expect the labor force participation rate to increase during recovery as discouraged workers come back into the labor force. The fact that the opposite is still happening means the unemployment rate will move higher (although 13% is sure to induce a double dip and I am not seeing this as a base case at this time).

Rosenberg’s political calculus also seems accurate.  In my post, “the politics of economics” I said that President Obama needs to take more blunt measures to deal with the unemployment situation head on.  Indirect measures are not going to be effective enough to prevent Democratic losses in 2010. Moreover, a recent poll released by Gallup today says that Republicans have now edged ahead of Democrats for 2010. If we see 12 or 13% unemployment, it will be much, much worse than that for the Democrats – and if Obama thinks getting his agenda through now is difficult, wait until 2011 when he may have to contend with more Republicans in Congress.

More of Rosenberg at the link below.

Source

Breakfast with Dave, 11 Nov 2009 (pdf) – David Rosenberg, Gluskin Sheff (free requires registration)

Related posts:

• Unemployment rate illusion
• Rosenberg: “the mother of all jobless recoveries”
• Unemployment Report: biggest rise in rate in two decades
• Comprehensive unemployment rate is 17.5%
• Spain: Bleak forecast puts unemployment at 22% in 2010

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Distraction of the Day: World’s dirtiest footballer?

Related posts:

• News from around the web: 2009-10-14
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• Links: 2009-07-17
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• News round-up: 30 Jul 2008

I have really started to dislike municipal bonds as an asset class. They have seen a huge rally along with almost every other financial asset but the underlying fundamentals are weak because of financial distress at states and municipalities.

Last week, I wrote a first piece on this topic, based on some work by Philip Greenspun and Fred Sheehan. I also just wrote a piece about Ambac Financial’s likely bankruptcy, which will impact this market because of Ambac’s municipal bond guarantees. But, a Barron’s piece about Jim Chanos of Kynikos called “Short Seller: Dump Munis” piqued my interest and precipitated this particular article.

Chanos is bearish

The Barron’s piece by Tom Sullivan said:

James Chanos, the famed short seller who was among the first to foresee the collapse of Enron, recently sounded the alarm on the municipal-bond market — in the hallowed halls of the New York Historical Society, no less.

The "cracking of state and local municipalities is coming," he predicted at a recent meeting attended by Barron’s staffer Susan Witty, adding that he wouldn’t touch munis.

In a subsequent telephone interview with this columnist, Chanos said, "State and local municipal finance are a mess and going to get worse."

It’s not just the recession, which has reduced tax receipts. Rather, he says the poor economy "is masking real problems in municipal cost structures." The big problem, he says, is "the platinum-plated health-care and retirement benefits" given to state and local workers. "It’s all coming home to roost" as boomers start to retire.

California faces a $60 billion deficit, and the politicians there believe that in "a worst-case scenario, the federal government will bail them out," says Chanos. "If the feds do bail them out, as I believe they will," the state’s bonds will likely lose their federal tax exemption, he adds.

Sullivan went on to use New York and New Jersey as other examples of what is amiss for state bonds.

Revenue shortfalls

A New York Times article which I linked to this morning makes the situation in New York plain, ending with this:

The comptroller’s office numbers are more pessimistic than those from Mr. Paterson’s budget office. They project that the deficit for the remainder of the current fiscal year stands at $4.1 billion, with deficits of $7.8 billion and $15.7 billion in the succeeding years.

Mr. Ravitch, who helped steer New York City through its financial crisis in the 1970s, said, “The numbers are real and my own personal view is that they’re going to get worse.”

New York and New Jersey are suffering the same problems that California suffered, namely a huge fall in income and property tax revenue. This is true all over the country in places as far apart as Oklahoma, Hawaii, Texas, and Georgia.

Assets falling, liabilities ballooning

But, it’s not just about revenues versus outlays – the income statement. It’s also about assets and liabilities – the balance sheet. recently I spoke to Peter Schweich, a retired vice president of Boston University and founder of Boston University Academy, who had done some research on municipalities in Massachusetts and he explained that his research indicated that municipalities had seen a 30% fall in investment portfolio values during the credit crisis (much obviously gained back since). Even worse, he pointed me to enormous looming liabilities not reflected on balance sheet or considered by the ratings agencies.  In a recent Forbes article, he wrote:

While municipalities are able to raise property taxes to cover current salaries, not without considerable pain to the taxpayer, few of them, if any, are prepared for the future financial demands of their grossly underfunded or completely unfunded Other Post Employment Benefits (OPEB) obligation. OPEB obligations are primarily associated with health benefits for retirees.

In 2006, the Federal Reserve Bank of Chicago held a pension conference. In a short note, it reported that a "back of the envelope guess" for OPEB was $700 billion and that "other estimates suggest that OPEB exposure could range from five to 10 times current outlays for retiree health care."…

Cambridge, Mass., now known to most Americans as the city where a homeowner can be arrested for "breaking into" his own home, serves as a good example of the overwhelming burden residential and business property owners across the country are about to confront. Current and future Cambridge residents are now facing a completely unfunded OPEB obligation of $602 million. That figure, alone, is nearly one-and-a-half half times greater than the city’s entire 2009 budget. In addition, like most municipalities, the recent economic downturn has resulted in a significant loss to Cambridge’s regular pension fund: a 28.6% loss in 2008 in the amount of $225 million.

In addition, Cambridge has an unfunded liability for its regular pension fund (distinct from the OPEB fund) to the tune of nearly $70 million, and, of course, Cambridge also carries bond obligations, as do many municipalities. The Cambridge bond obligation exceeds $300 million. This means Cambridge, with approximately 75,000 permanent non-university student residents, one municipal employee for every 22 residents, and 22,000 taxable parcels, has current financial liabilities of nearly $1.2 billion…

Not surprisingly, the Cambridge city manager boasts of Cambridge’s financial stability each year in the introductory letter to his submitted budget. To bolster his claim, he proudly points to the Triple A bond ratings that Cambridge holds from Moody’s, Fitch and S&P. Cambridge, therefore, has 75,000 residents, 22,000 taxable parcels, $1.2 billion in financial liabilities–and a Triple A bond rating from Moody’s, S&P and Fitch.

These are circumstances that are being repeated across the United States. Expect scandals involving alleged improprieties to mount when financial distress hits. One notable example in the news is San Diego, where the top pension administrator is exiting after last year’s over 25% loss and where the fund is also being buffeted by two separate scandals: a conflict of interest scandal and a scandal where overtime pay was counted toward the formula in firefighters’ pension overtime. San Diego was also in the news a few years back because of a separate scandal where an alleged special pension benefit for the fire chief was under attack. See also San Diego’s Pension Scandal for Dummies from 2005, which details the conflict of interest case to that date.

Ratings agency problems

Then there are the rating agencies. Remember the whistleblower scandal from last month? It was all about municipal bonds and the Moody’s allegedly putting their revenue generating relationship with municipalities ahead of the rating function. If you recall, it was exactly this conflict of interest which led to Arthur Andersen’s downfall in the Enron scandal.

This is what Reuters said about the Moody’s whisteblower scandal last month:

Two former Moody’s executives — Scott McCleskey and Eric Kolchinsky — testified that senior managers were willing to silence employees who raised concerns about the ratings process or compliance efforts.

McCleskey said that while he was the head of compliance at Moody’s, he voiced concerns that the firm was not properly monitoring ratings on municipal debt. McCleskey, who was dismissed by Moody’s in 2008, said he was instructed not to mention the issue in e-mails or writing.

Kolchinsky, a Moody’s managing director who was recently suspended by the firm, said senior managers pushed revenue over ratings quality and were willing to fire employees who disagreed.

The two whistleblowers were flanked by Moody’s current chief credit officer, Richard Cantor. Cantor sat impassively, staring straight ahead as his former colleagues described their concerns to the lawmakers.

In his testimony, Cantor said Moody’s had recently hired an independent law firm to review Kolchinsky’s allegations.

That was criticized as an empty gesture by Chairman Towns, who said the law firm had no deadline and would not produce a written report.

Kolchinsky told lawmakers that Moody’s compliance group was understaffed and lacked independence. He also alleged Moody’s knowingly issued misleading ratings on complex securities and that analysts were "bullied" by managers, who overrode their decisions to protect revenue.  Kolchinsky said he would soon meet with the SEC to discuss his charges. SEC officials said the regulator had contacted Kolchinsky about his concerns in March 2009.

McCleskey, meanwhile, sent the SEC a letter in March 2009 warning about Moody’s weak compliance department and ratings process. He said Moody’s management had ignored his warnings that the company failed to properly monitor municipal bond ratings.

The company also spurned his suggestion to erect a firewall between the compliance department and its revenue-generating units, he said.

No doubt, there are those who are still recommending munis because of their tax-free status, as a recent WSJ article demonstrated. But, the fundamentals are weak and getting worse – both in terms of the income statement and the balance sheet. These governments are soon to lose their guarantees from Ambac (and eventually MBIA despite hiving off the muni business). To my surprise, these governments are getting no federal government backstop as the California situation has demonstrated. And the Fed and Treasury are on record as saying they will not guarantee any municipal bonds. Finally, I question whether one should rely on the ratings these bonds have to make an informed investment decision. Even the junk-bond king Michael Milken, a credit analyst of note, is now warning that credit ratings are inflated.

Municipal bonds are a clear case of buyer beware.

Related posts:

• The coming collapse of the municipal bond market
• MBIA and Ambac sued by LA
• Ambac may file bankruptcy soon
• California starts issuing IOUs as bankruptcy nears
• State and local government weighed down by housing

Bond insurer Ambac Financial has warned bankruptcy is a distinct possibility, sending its shares plummeting more than 30% today.

What is intriguing about this pending bankruptcy is how this company escaped bankruptcy in 2008, was downgraded continually in 2009, yet just reported billions in profit 5 days ago. Now it warns of bankruptcy? 

This story also is related to municipal bonds.

Rewind to July of last year and Ambac was headed to zero fast after having been downgraded by S&P the month before. Basically, their business model of using a AAA rating to guarantee bonds (a sort of credit default insurance) was rendered non-viable by the credit crunch.

But in November, Ambac was able to forestall the inevitable. On November 19th, MarketWatch reported:

Ambac said late Wednesday that it commuted, or tore up, roughly $3.5 billion worth of guarantees on complex mortgage-related vehicles known as collateralized debt obligations. The company’s main bond insurance unit paid counterparties $1 billion in cash to settle the contracts.

The deal will improve the capital position of the bond insurance unit for rating agencies, Ambac said.

Later the insurance subsidiary eliminated its dividend to the parent company.

When the company rejected an unsolicited offer by Warren Buffett to reinsure $800 billion in municipal bonds insured by Ambac and MBIA in December, this was generally seen as a sign of strength. But, the company was holding on by a thread.

Then came the potential for a big bailout in March. MarketWatch again:

Life and bond insurers soared after the announcement Monday that they will be eligible to participate in the Treasury Department’s Public Private Partnership Investment Program.

Bond insurer Ambac Financial Group is one that will investigate Treasury’s offer to backstop a market for securities it holds in its investments, said Ambac spokeswoman Vandana Sharma.

The public-private program will use $75 billion to $100 billion in money from the Troubled Asset Relief Program called TARP to generate $500 billion in purchasing power to buy legacy assets held by investors, with a government backstop encouraging private sector investors to purchase the assets.

"A broad array of investors are expected to participate in the Legacy Loans Program," the Treasury said in a fact sheet it provided Monday. "The participation of individual investors, pension plans, insurance companies and other long-term investors is particularly encouraged."

Up to now, insurers such as Ambac have unsuccessfully lobbied for inclusion in government programs that have offered capital to help make up for losses tied to mortgage loans.

Ambac did not get TARP money.  All the while, the two companies MBIA and Ambac continued to be downgraded by the ratings agencies – dead men walking.

But just five days ago, Housing Wire reported the following:

Bond insurer Ambac Financial Group posted net income of $2.2bn, or $7.58 per share, in Q309, compared with a net loss of $2.4bn in the year-ago quarter.

Quarterly results were impacted by unrealized mark-to-market gains in the New York City-based financial services and insurance firm’s credit derivatives portfolio and gains from Q309 reinsurance cancellations.

The firm experienced a positive $2.1bn change in fair value of credit derivatives, driven by the adjustment made under Financial Accounting Standard (FAS) 157 relating to Ambac’s widening credit spread…

“We continue to make progress in de-risking the balance sheet via negotiated reinsurance buy-backs, CDO of ABS commutations, settlements related to defaulted RMBS transactions as well as expanded analysis of expected recoveries relating to RMBS representation and warranty breaches,” said president and CEO David Wallis.

Nice, right?  Well, now they could be filing for bankruptcy.

The muni connection comes from the fact that Ambac was a large guarantor in the municipal bond market. Witness this ill-timed article from Fortune in February 2008:

Forget what you may have read in the newspaper about state budget problems or bond insurer meltdowns. This is a perfect time to be buying municipal bonds. The economy is slowing, the Federal Reserve is poised for more interest rate cuts (boosting bond prices), and a Democratic win in November would probably lead to higher taxes on the rich, thereby enhancing munis’ tax advantages. Throw in munis’ microscopic default rates, and you’ve got an ideal landing spot for investors weary of the stock market roller coaster…

As we said, the default rate on munis is minuscule, especially for GOs, water-and-sewer revenue bonds, and the other plain-vanilla offerings that make up the majority of the muni market. Even triple-B-rated munis – the lowest rung of investment grade – have a default rate of only 0.06 percent…

Over the years, this incongruity has fueled the growth of Ambac (ABK), MBIA (MBI) and other bond insurance companies. By selling states and cities insurance that turns triple-B and single-A bond issues into triple-A’s – reducing government borrowing costs in the process – the bond insurers manage to pocket much of the extra yield that would otherwise go to investors. Best of all, bond insurers rarely had to pay claims, certainly not on the plain-vanilla GOs and water-and-sewer bonds. "In my opinion," says Paul Disdier, who oversees the municipal bond fund division at Dreyfus, "the worst thing to happen to the muni market is the spread of bond insurance."

I’m sure you know that the spread is actually not the worst thing here. It’s that risk was being underpriced. That’s why Ambac is hitting the wall. And so it is again.

By the way, the Fed and the Treasury are on record as being leery of guaranteeing anything in the municipal bond market. So, with Ambac crumbling and no Federal government backstop, there is no safety net for bad investments in munis. Caveat Emptor.

Update: To be clear – Ambac Financial, the parent entity is filing for bankruptcy. But Ambac Assurance, which is the insurance subsidiary is not. Nevertheless, Ambac Assurance still has a Caa2/CC rating and we should anticipate it will be soon to be out of business.

Update 2: see the following Bloomberg article for detailed information on the potential bankruptcy filing and associated market action: Ambac, MBIA Tumble as Losses May Overwhelm Bond Insurers.

Related posts:

• MBIA and Ambac sued by LA
• MBIA, Ambac, $1 Trillion of Debt, Lose S&P AAA Rating
• Ambac is going to zero fast
• The coming collapse of the municipal bond market
• AIG: looking to raise $20 billion

Tilson is saying what I have been saying, namely that March saw an increased number of attractive buys, but most of these are now fully priced. As a result, he is selling equities – even building up his net short positions.

Unlike bear turned bull Richard Bernstein, Tilson says that after a huge 60%+ run up which saw a trebling or quintupling of some beaten up shares like Huntsman, you need to be cautious. Invest in high quality and low beta, he says – exactly the opposite of what Bernstein is now saying.

Despite some positive earnings reports from the likes of Toll Brothers, the sector he hates the most right now is home builders because of a 2-year inventory overhang.

Below Tilson talks to Bloomberg’s Carol Massar. The video runs just over 3 minutes.

Related posts:

• Whitney Tilson of T2 Partners, a new media darling, strikes a bullish tone
• Richard Bernstein: Once a huge market bear, now a bull
• Which homebuilder will go bankrupt next?
• Bernstein: What kind of recovery are we going to get?
• Are the markets set for a pullback?

Andy Xie thinks the Fed is on an inflationary path.  Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

If stagflation is the goal, why might central banks such as the Fed talk tough about inflation now? The purpose is to persuade bondholders to accept low bond yields. The Fed is effectively influencing mortgage interest rates by buying Fannie Mae bonds. This is the most important aspect of the Fed’s stimulus policy. It effectively limits Treasury yields, too. The Fed would be in no position to buy if all Treasury holders decide to sell, and high Treasury yields would push down the property market once again.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret.  There is really no other policy choice because the mountain of debt in the United States is immense.  And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do?  China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate?  Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

The point is that Japan has a strong and genuine case that favors more integration with East Asia. The United States is unlikely to recover soon and with enough strength to feed Japan’s export machine again. There is no more room for fiscal stimulus. Devaluing the yen to gain market share is not an option as long as Washington pursues a weak dollar policy. Without a new source of trade, Japan’s economy is doomed. Closer integration with East Asia is the only way out…

Five years ago, I wrote an op-ed piece for the Financial Times entitled China and Japan: Natural Partners. At the time, a prevailing sentiment was that China and Japan were antithetical: Both were still manufacturing export-led economies and could only gain at the other’s expense. I saw complementary demographics and capital: Japan had a declining labor force and China needed to employ tens of millions of youths migrating to cities from the countryside. China needed capital and Japan had surplus capital. And their trade relations indeed tightened, as Japan had increased the Chinese share of its overall trade to 17.4 percent in 2008 from 10.4 percent in ‘04.

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea.  Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

Related posts:

• Stephen Roach: Downturn in Asia less severe, but recovery later
• China: reflation play spells trouble for rest of the world
• Chart of the day: Aussie – Yen cross
• The Dollar
• China warns that the west’s quantitative easing is inflationary

This comes from the Guardian (hat tip Lee):

The world is much closer to running out of oil than official estimates admit, according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying.

The senior official claims the US has played an influential role in encouraging the watchdog to underplay the rate of decline from existing oil fields while overplaying the chances of finding new reserves.

The allegations raise serious questions about the accuracy of the organisation’s latest World Energy Outlook on oil demand and supply to be published tomorrow – which is used by the British and many other governments to help guide their wider energy and climate change policies.

In particular they question the prediction in the last World Economic Outlook, believed to be repeated again this year, that oil production can be raised from its current level of 83m barrels a day to 105m barrels. External critics have frequently argued that this cannot be substantiated by firm evidence and say the world has already passed its peak in oil production.

Conspiracy theorists will love this one! But, we don’t need a conspiracy theory to see that the end of cheap oil is upon us. To find high quality oil deposits (I am not talking about Oil Sands in Alberta here) is becoming more and more expensive. And one oil field after another is hitting peak. We have seen it in Mexico, Russia, the North Sea, the Alaskan North Slope and elsewhere.  The only thing keeping us from realizing the peak is Saudi Arabia, the swing producer in OPEC.

In June of last year, I said:

There has been a lot of speculation of late regarding oil field production capacities declining. In particular, there are great worries regarding Russian and Saudi production capacities. The available data on Saudi production is especially opaque. Matthew Simmons, an expert oil investment banker, has written a book questioning the data the Saudis have provided regarding the proven reserves available for production and the production capacity of the Saudis major fields including Super Giant Ghawar, the largest oil field in the world. I recommend anyone interested in this debate read his book, “Twilight in the Desert.”

This leads us to the Armageddon Scenario. Nuclear-armed nations like China, Russia, India and the United States are desperate to keep their standard of living up. As a result, with oil supplies dwindling, competition for oil supplies will increase. The risk of armed conflict to procure necessary supply increases as peak oil becomes apparent. The U.S. has invaded Iraq, has troops stationed in Saudi Arabia and is threatening Iran, all because of oil — and in Iran’s case, the possibility of another nuclear-armed nation entering the strategic quest for oil. This is a battle of extreme importance strategically for a number of countries. They may stop at nothing to achieve their ends should peak oil become a problem.

Of course, this is exactly why China is all over South America and Africa.

As for peak oil, the lower-48 United States peak of 1970 was not recognized until years later. The same will be true again for the global peak. High oil prices are not just a reflection of speculation, there are some very real supply demand imbalances building. Recession has suppressed these, but in a more normal economic environment, oil prices are going to rise.

Related posts:

• Peak oil: are we there yet?
• Peak oil: it’s all about the Saudis
• Drilling for oil
• What happened to peak oil?
• Iran finds huge billion barrel oil field

• Financial Armageddon: In-Your-Face Influence Peddling
• FT.com – Not all bubbles present a risk to the economy (Blinkered Fed thinking on asset bubbles. Reminiscent of the Greenspan era.)
• Fitch Says U.K. Rating Most at Risk Among Top-Rated – Bloomberg.com
• Japan faces risk of ratings downgrade over debt| Currencies| Reuters
• Mishkin Defend Bubbles (and of Course, the Fed) – Yves Smith
• FT Alphaville – Barclays’ Protium-purified balance sheet (Who says accounting doesn’t matter.)
• The Edwards Strikes Back (I like the Han Solo comparison.)
• On the Brink, New York Must Cut, Paterson Says – NYTimes.com
• BBC NEWS | UK | Wales | Jobless man’s 45m lottery ticket
• Google’s Late Release of Android 2.0 Hurting Developers | Android Tapp. Android App Reviews
• Just lay back and think of it as a Vagina Added Tax – Firedog Lake
• House prices continue to rise despite increased availability | Money | guardian.co.uk
• Brace yourselves for Credit Crunch II . . . – Times Online
• Goldman Sachs: You Think God Would Let ‘Egomaniacs’ Work Here? – Dealbreaker
• The Information Broker – Andrew Ross Sorkin – nymag.com
• Stuyvesant Town woes may pave way for loan changes | Reuters
• Making Wall Street pay | Dean Baker | Comment is free | guardian.co.uk
• BBC NEWS | Business | GMAC to get more bail-out funds
• David Einhorn vs the bloggers on credit default swaps – FT Alphaville
• Banks Choosing Treasury Bonds Over Loans – Real Time Economics – WSJ
• The other shoe drops at Caijing – James Fallows
• Larry Johnson Released by Chiefs After Inflammatory Tweets

Related posts:

• Links: 2009-09-30
• Links: 2009-10-23
• Links: 2009-03-08
• Links: 2009-04-02
• Links: 2009-02-19

Columbia University Professor and former Federal Reserve official Frederic Mishkin wrote a much-discussed Op-Ed in the Financial Times yesterday. In it, he asks

Are potential asset-price bubbles always dangerous?

He answers this question with a no, noting that some asset bubbles are more dangerous than others because of their connection to debt and credit. I agree with his delineation and assertion that some asset bubbles are more dangerous than others. But, his conclusion that the non-credit variety of asset bubble — what he calls the “pure irrational exuberance bubble” — is not dangerous is false. This is the same blinkered thinking which led to Nasdaq 5000 and its crash. Experience demonstrates that all asset bubbles are dangerous, some asset bubbles are more dangerous than others. Think Animal Farm: All bubbles are equal, but some bubbles are more equal than others.

The real question Mishkin attempts to answer is whether the Federal Reserve (where he once worked) or any other central bank should target asset prices so as to prevent bubbles from taking form.

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Are we to take this seriously?  Even Alan Greenspan is showing more realism in the wake of our latest bubble.  This man is outright dangerous.  Don’t be fooled; his piece is a plant. We have some serious asset bubbles forming right now and he is looking to give intellectual cover to the watch-the-bubble-and-clean-up-after-the-mess policy we saw on display in the late 1990s. Yves Smith thinks there is a connection between his statement and likely Federal Reserve policy.

What I find interesting is how the Federal Reserve under Greenspan had an explicit policy of targeting asset prices as a means of reflating the economy. Yet, Mishkin is saying they should not target asset prices as a means of deflating the economy. This is what is called monetary policy asymmetry, otherwise known as the Greenspan Put. It’s not about targeting asset prices but looking for excess credit growth, which was certainly on display in the Nasdaq boom as well.

In effect, Mishkin is arguing for us to continue with business as usual. This is one of the more loathsome pieces of prattle I have witnessed since the financial crisis began. I hope no one takes this man seriously. I am ashamed that he is a professor at the business school I attended.

I would be remiss if I didn’t point out his equally absurd piece of research on Iceland’s economy before it collapsed. he wrote a piece called “Financial Stability in Iceland” with Tryggvi Herbertsson which stated:

Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided.

No, Mr. Mishkin your analysis is misguided. It was with Iceland and it is here again. See below for a real analysis on Iceland from Willem Buiter and Anne Sibert which we can take seriously.

As I have been saying, you can get wildly different conclusions from two people based on the same facts and largely the same analysis. It goes to philosophical predisposition.  What this FT article by Mishkin demonstrates is that no amount of real world evidence of the havoc that bubbles wreak will dissuade these ivory tower ideologues from supporting failed economic policy.

Sources

Not all bubbles present a risk to the economy – Frederic Mishkin, FT

Financial Stability in Iceland (pdf) – Icelandic Chamber of Commerce

The collapse of Iceland’s banks: the predictable end of a non-viable business model – VoxEU

Central Banks Can Do Better Than Just Mopping Up – Caroline Baum, Bloomberg

Related posts:

• Popping bubbles
• Federal Reserve’s Fisher says tightening will be aggressive
• Japan’s easy money policy was the trigger for the tech wreck
• Quote of the day: William White and inflation
• Bank leverage: forever blowing bubbles part two

I am feeling fairly ill so posting will be light today. Hopefully, I will back in shape tomorrow.

• VIDEO: Former Brit Ambassador Craig Murray Says UK and USA Sent Prisoners to Uzbekistan for Torture Part 1 Patrick J. Buchanan

  Chilling. Must-see video

• Former UK Ambassador: CIA Sent People To Be ‘Raped With Broken Bottles’ « Patrick J. Buchanan
• Federal Reserve Says Judge Erred in Requiring Bank Disclosure – Bloomberg.com
• FT.com | Willem Buiter’s Maverecon | Gold – a six thousand year-old bubble

  "Because to a reasonable first approximation gold has no intrinsic value as a consumption good or a producer good, it is an example of what I call a fiat (physical) commodity. You will be familiar with fiat currency. Unlike what Wikipedia says on the subject, the essence of fiat money is not that it is money declared by a government to be legal tender. It need not derive its value from the government demanding it in payment of taxes or insisting it should be accepted within the national jurisdiction in settlement of debt. Instead the defining property of fiat money is that it has no intrinsic value and derives any value it has only from the shared belief by a sufficient number of economic actors that it has that value."

• Mirror closes final salary pension plan to existing members – Telegraph
• Public Pensions Face Ugly Choices – Forbes.com
• Editorial – Jobless Recovery – NYTimes.com
• Economists Seek to Cure a Defect in National Data – NYTimes.com

  I have been invited to this event. Not sure yet if I can attend. But let’s applaud the effort to overall the government’s statistics.

• FT.com – Clive Crook – Obama has lost sight of the centre
• For brave investors, Zimbabwe could be the ultimate turnaround story – Telegraph
• 50 Apps For New Droid Owners | Android Phone Fans
• Gold Climbs to Record as Weaker Dollar Boosts Investment Demand – Bloomberg.com
• Sir Alex Ferguson to avoid FA charge for Chelsea referee comments |Football |guardian.co.uk

  Sir Alex is a menace and should face FA charges for this.

• Advanta files for bankruptcy protection | Reuters
• Cambridge Runs Amok – Forbes.com
• Abschluss-Doku des gescheiterten Opel-Verkaufs Blick Log
• The Becker-Posner Blog: Productivity and Unemployment–Posner

  Productivity gains that result from job cuts and recession are not the same as those that result from technological improvements.

• I’m doing ‘God’s work’. Meet Mr Goldman Sachs – Times Online
• Lieberman Says Again He’ll Join Filibuster — Political Wire
• Short Seller: Dump Munis – Current Yield – Tom Sullivan – Barrons.com
• The Economics of Trust – Forbes.com
• Frank Rich- The Night They Drove the Tea Partiers Down – NYTimes.com
• Strong US recovery biggest threat to Australia

  ASK economic guru David Hale about the worst risk facing Australia and you will get a surprising answer. ”It’s a really strong United States recovery,” he said. ”The V-shape that some people are talking about. It would force the Fed to push up rates quite quickly in the second half of next year, not from zero to 1 per cent, but from zero to 2 or 3; it would reverse the big rally in the Australian dollar and it might provoke a big global stock market correction.”

• FSA probe HBOS information accuracy – Independent.ie
• Hitlers barndomshjem til salgs for 18,5 mill. kr. | Eiendom Utenriks | E24

Distraction of the Day: Man drives car into courthouse

Related posts:

• Links: 2009-01-25
• News from around the web: 2009-11-05
• News round-up: 13 Oct 2008
• News round-up: 30 Jul 2008
• Links: 2009-02-21

In the wake of a few significant elections in the American states of New York, New Jersey and Virginia, a lot of pundits are putting their spin on what these elections mean for Barack Obama and his political agenda. On the whole, I find most of the conclusions partisan leaps of faith.

So, I wanted to take this issue on and outline my thoughts on American politics and the feedback loop with the economy. I will then try to take on what the election last November and just this past week mean in regards to Obama’s political agenda and the missteps I believe he made early in his tenure as President.

Confabulation and the human need to explain

First, let me start off with a basic concept of behavioral psychology: confabulation.  Back in April, I quoted from an article in New Scientist about how people will develop false narratives to explain away decisions already made. This is called confabulation. The article says:

As anyone who has ever been in a verbal disagreement can attest, people tend to give elaborate justifications for their decisions, which we have every reason to believe are nothing more than rationalisations after the event. To prove such people wrong, though, or even provide enough evidence to change their mind, is an entirely different matter: who are you to say what my reasons are?

But with choice blindness we drive a large wedge between intentions and actions in the mind. As our participants give us verbal explanations about choices they never made, we can show them beyond doubt – and prove it – that what they say cannot be true. So our experiments offer a unique window into confabulation (the story-telling we do to justify things after the fact) that is otherwise very difficult to come by. We can compare everyday explanations with those under lab conditions, looking for such things as the amount of detail in descriptions, how coherent the narrative is, the emotional tone, or even the timing or flow of the speech. Then we can create a theoretical framework to analyse any kind of exchange.

What experimenters here have shown is that there is a real human need to explain. Things happen for a reason, don’t they?  Why did the stock market rally? Why did Harry do that? Why didn’t we do something to stop this? Why did I vote for that guy back then, when I now don’t like him as much?

To the degree there is an explanation void, it will be filled. The question is: filled with what?

Confirmation bias and the psychology of politics

In politics, how the void gets filled has much to do with philosophical/political predisposition and one’s world view.

Drew Westen, a professor of psychology at Emory University, published an interesting book a few years back called “The Political Brain.” Recently, Westen has had some important things to say about the psychology of the health care debate (see Washington Post article here). But, in the book, the most memorable political psychological experiment Westen described is very much related to confabulation. I quoted from Wikipedia’s synopsis of this experiment to explain confirmation bias in the econoblogosphere back in May:

In January 2006 a group of scientists led by Westen announced at the annual Society for Personality and Social Psychology conference in Palm Springs, California the results of a study in which functional magnetic resonance imaging (fMRI) showed that self-described Democrats and Republicans responded to negative remarks about their political candidate of choice in systematically biased ways.

Specifically, when Republican test subjects were shown self-contradictory quotes by George W. Bush and when Democratic test subjects were shown self-contradictory quotes by John Kerry, both groups tended to explain away the apparent contradictions in a manner biased to favor their candidate of choice. Similarly, areas of the brain responsible for reasoning(presumably the prefrontal cortex) did not respond during these conclusions while areas of the brain controlling emotions (presumably the amygdala and/or cingulate gyrus) showed increased activity as compared to the subject’s responses to politically neutral statements associated with politically neutral people (such as Tom Hanks).[2]

Subjects were then presented with information that exonerated their candidate of choice. When this occurred, areas of the brain involved in reward processing (presumably theorbitofrontal cortex and/or striatum / nucleus accumbens) showed increased activity.

Dr. Westen said,

None of the circuits involved in conscious reasoning were particularly engaged… Essentially, it appears as if partisans twirl the cognitive kaleidoscope until they get the conclusions they want… Everyone… may reason to emotionally biased judgments when they have a vested interest in how to interpret ‘the facts.’[3]

The study was published in the Journal of Cognitive Neuroscience 18:11, pp. 1947–58, a peer-reviewed scientific journal.[1]

Even before being peer-reviewed and published, Michael Shermer used the presentation by Dr. Westen as the basis for his July 2006 Skeptic column[4] in the magazine Scientific American.

In essence, political partisans with a well-developed political world view were confronted with data that did not fit their particular view.  This created cognitive dissonance and mental stress (remember, the brain areas for reason were not activated here, emotions were at play).  Their brains, rather than trying to resolve the conflict objectively, looked for ways to incorporate the new information into the previous pre-conceived view. When the subjects successfully accomplished this back flip, they were massively rewarded by the areas of the brain for pleasure.

In sum, our brains are NOT hard-wired for non-confirmatory evidence. We are not rewarded for seeking non-confirming data. Therefore, we generally seek confirmatory evidence after we have made any decision.

When you read the narratives of the recent election results, you should realize that confirmation bias is very much at play in tweaking the conclusion to fit a preconceived world view.  A perfect example is a recent piece by Charles Krauthamer in the Washington Post.

Speaking of a huge Democratic loss in Virginia, Krauthamer says:

In the aftermath of last year’s Obama sweep, we heard endlessly about its fundamental, revolutionary, transformational nature. How it was ushering in an FDR-like realignment for the 21st century in which new demographics — most prominently, rising minorities and the young — would bury the GOP far into the future. One book proclaimed "The Death of Conservatism," while the more modest merely predicted the terminal decline of the Republican Party into a regional party of the Deep South or a rump party of marginalized angry white men.

This was all ridiculous from the beginning. The ‘08 election was a historical anomaly. A uniquely charismatic candidate was running at a time of deep war weariness, with an intensely unpopular Republican president, against a politically incompetent opponent, amid the greatest financial collapse since the Great Depression. And still he won by only seven points.

Exactly a year later comes the empirical validation of that skepticism. Virginia — presumed harbinger of the new realignment, having gone Democratic in ‘08 for the first time in 44 years — went red again. With a vengeance. Barack Obama had carried it by six points. The Republican gubernatorial candidate won by 17 — a 23-point swing. New Jersey went from plus-15 Democratic in 2008 to minus-four in 2009. A 19-point swing.

Obama also benefitted in 2008 from unique circumstances with the recession and economic crisis favoring a change candidate. That uniqueness can be seen in the huge drop in young and black voters last week as well as the switch in independent voter allegiance from Democrat to Republican. I guarantee you we would have seen similar results in favor of George W. Bush had the recession of 2001 and 9/11 occurred one year earlier. None of these factors favored Democrats in 2009.

Krauthamer goes on to make some partisan claims about left-leaning agendas, hubris and taxation that I found unconvincing (Clive Cook also does this). I wished he had stopped here because he makes a valid point: the 2008 election was not some magical moment in American history in which we saw a sea change in political alignment at one moment in time. That’s confabulation, pure and simple.

What happened is Americans voted for those people who they felt would change course because they felt the country was headed in the wrong direction. That’s certainly what exit polling told us in November 2008.  Making up some other explanation is not necessary.

I know change when I see it and this is not it

So, what Charles Krauthamer and Clive Cook are doing along with Frank Rich and Paul Krugman is filling the explanation void. I agree with the analysis, but some of the conclusions are more dubious. I have done my share of filling that void (I see Frank Rich’s narrative as the one closest to mine).

But, for a moment, let’s leave the explanations aside. The great thing is humans are capable of complex decision-making and thought without having to explain those decisions. We know how to distinguish a frog from a prince and a pig from a princess – no explanation required.

And so it is here again. If you asked 1000 people in those exit polls from November 2008 – or even last week, “what would make you know America was headed in the right direction,” you probably would have gotten 700 different answers.

But, one thing is clear: Since January 20th, a lot of people are saying to themselves, “I know change when I see it and this is not it.” That’s what all polls are saying. So, whatever Obama and the Democratically-controlled Congress are doing, it’s not working.

Enter the Demagogue

That’s where demagoguery comes into play. Demagogues love an explanation vacuum.  Since time immemorial, where there has been public disenchantment with the status quo, there has always been some demagogue waiting in the wings with a ready-set explanation of what’s wrong and how they were going to fix it. These are people who are considered fringe elements in good times, but when economic hardship comes their ready-made explanations and confabulation become a toxic mix which propels them to prominence. (For the record, I am not connecting the gentlemen mentioned above with demagoguery. I am making a separate point here).

I would argue, that’s where we are right now. The global economy has just experienced an incredible shock. In the United States, more than one in six is unemployed or underemployed. Personal bankruptcies and foreclosures are still happening in record numbers. The economic situation is, in a word, grim.

Therefore, people are going to more open to a wider range of ideas and this is a prime opportunity for demagogues to advantage themselves and their allies. It also should make any incumbent politician very afraid of losing their job.

With this in mind, I look back to the early days of Barack Obama’s tenure and I can’t help but conclude that his economic strategy was too timid, too much aligned with the status quo. It’s not as if this should be a shocker; I pointed this out in January and again in February. His economic team erred in believing, as the Bush Administration had done, that the economic and financial situation was better than it was.  Remember, Obama’s stimulus plan was based on a forecast of 8.0% unemployment.

Future policy decisions

But that ship has sailed and here we are a year after Obama’s election in a technical but unsatisfactory statistical recovery. What should Obama do going forward?

Well, first of all, what he needs to do is give voters a sense that the recovery is for real. And that means unemployment, foreclosures, and stagnant personal income must be attacked. On some level, the health care debate is a net negative in that it consumes a lot of political capital without any obvious and immediate economic benefit. The bailouts and financial reform agenda also have been net negatives as well for similar reasons but also because they have not been seen as fundamental change and they further disenchantment.

Moreover, we know that the explanation vacuum is being filled by voices decrying big government and socialism. If you listen to people like Charles Krauthamer, you are likely to see Obama as a dangerous shift in America to the left. He makes a compelling argument which will sway those who are constitutionally predisposed to hating big government or deficit spending. So this means Obama is now constrained. In my view, fiscal stimulus is a political non-starter.

So, I see jobs as the first area for Obama to attack. The question is whether he does this directly via some modified private-sector controlled W.P.A.-type program or indirectly via something like a payroll tax cut. After jobs comes foreclosure. Personal income and taxes are the least important area going forward (especially as any tax cuts will either increase deficit spending or have to be made up by tax increases elsewhere).

If the economy turns up vigorously and permanently, we can put some of these thoughts to rest. You have to believe many fewer people would be yelling socialism or corporate communism if we were in a robust upturn. However, I don’t think that is a likely economic scenario. Even so, the unique circumstances of 2008 are unlikely to be repeated. That spells trouble for the Democrats in 2010 and 2012 unless they start doing something dramatically different.

Other sources

People Sometimes Seek The Truth, But Most Prefer Like-minded Views – Science Daily

Humans prefer cockiness to expertise – NewScientist (think demagogue here)

Related posts:

• Through a glass darkly: the economy and confirmation bias in the econoblogosphere
• Loss aversion and finding a bottom
• What motivates Hillary? Part 2
• Peer pressure and bubbles
• US Senate passes Economic Patriot Act 74-25

The long-coming commercial real estate bust has arrived in the U.S. and elsewhere, a result of sky-high prices met by a severe downturn.  Prices could only work in a best-case economic scenario and large busts are now coming (see my posts on Stuyvesant Town and Capmark Financial).

This bust is certainly another major impediment to a sustained recovery – along with a host of other wild cards like unemployment, trade conflict, and oil prices. But, the most worrying aspect about the CRE market is the marks on the balance sheets of our capital-constrained banks, which do not reflect the level of distress evident in the marketplace. And since securitization plagues the CRE market, some analysts expect bankruptcy to be the only workout option for many troubled deals. You will recall, this problem with securitized assets is a dynamic which has also plagued residential real estate (see posts here and here).

The video below explains how this real estate bust is different and what it will mean for the U.S. economy and likely bank failures. (Sorry that it starts automatically. If the wrong video pops up, see the link below).

Related posts:

• Circuit City as canary in the coalmine for commercial real estate
• Commercial Real Estate bust
• Commercial real estate is next
• Commercial poperty ‘im Visier’
• Commercial real estate: down even more than residential

This is pretty funny. Hat Tip Rob Johnson and New Deal 2.0.

Source

Money performed by Cypress Hill – Answers.com

What does "dollar, dollar bill, y’all" mean? – Yahoo! Answers

Related posts:

• Simon Johnson: Too big to fail is “too big to exist”
• Application for the Federal Bail Out Program, 2008-2009
• Dilbert on the asset-based economy
• Bank of America cuts its dividend
• Saturday Night Live Grades the Stress Tests

That’s how my friend Jeff described the most recent flap over a banker allegedly using religion to defend the industry.

If you haven’t caught it, Goldman Sachs CEO Lloyd Blankfein was quoted in the Sunday London Times as saying “we have a social purpose,” in referring to the banking industry. What caught everyone’s eye was the headline: “I’m doing ‘God’s work’. Meet Mr Goldman Sachs,” something sure to inflame already raw feelings against bankers worldwide. And this comes after John Varley (the CEO of the soon-to-be-considered-vampire-squid of Britain when it shows record profits) invoked religion in talking of banking – in an inappropriate defence of British banks at church.

Quite frankly, Blankfein’s comments are not what I would consider good PR for the banking industry or Goldmans in light of the recent flap over Goldmans’ Lord Griffiths’ inflammatory comments on how Britons must:

tolerate the inequality as a way to achieve greater prosperity for all.

Remember, this is the same company pejoratively labelled Government Sachs and a vampire squid.

But, what did Lloyd Blankfein actually say? Here’s the quote from the Times.

Luckily for him and his firm, he’s a damn good salesman. He starts with a little humility. He understands that "people are pissed off, mad, and bent out of shape" at bankers’ actions. Goldman played its part in the meltdown that almost destroyed the global financial system. It, like most other banks, lent too much money, made its first quarterly loss for more than a decade last year and ended up taking bail-out cash from Washington. "I know I could slit my wrists and people would cheer," he says. But then, he slowly begins to argue the case for modern banking. "We’re very important," he says, abandoning self-flagellation. "We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle." To drive home his point, he makes a remarkably bold claim. "We have a social purpose."

Do you see anything in this quote about God’s work? I clicked on this article expecting to see something outrageous of the Lord Griffiths variety. I don’t. So, why is the headline pointing to these statements as ‘God’s Work?’ I think the headline is reckless and misleading. Its sole purpose is to inflame anti-Goldman sentiment. The language of the article is construed to cast Blankfein and Goldman in a negative light. This is not what I consider the best of journalism in the least.

So, let’s look at the actual merits of what was said.

• “people are pissed off, mad, and bent out of shape” – I’m glad you realize this. But paying record bonuses doesn’t sound like you understand the gravity of the situation or how pissed off people are.
• “I know I could slit my wrists and people would cheer” – exactly. So you should be as meek as a mouse right now.
• “We’re very important" – poor choice of words, my friend. See the previous statement.
• "We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle." – YES! That’s the bloody point here. I see this as an accurate statement of the social purpose of investment banking.
• "We have a social purpose." – In fact, you do.

Later, in the same article comes the money quote:

An impish grin spreads across Blankfein’s face. Call him a fat cat who mocks the public. Call him wicked. Call him what you will. He is, he says, just a banker "doing God’s work"

This looks to be a very damning quote, doesn’t it? Three little words. What was the context here? I’d like to see this quote contextualized like the paragraph I deconstructed above.

So, how do I see this issue?  Investment banking does indeed have a social purpose. In fact, it is the one stated quite well by none other than Lloyd Blankfein. Whether bankers are fulfilling this purpose and how much they should earn for doing so are wholly different questions (see Bookstaber’s question “Why do bankers make so much money?”). But, trying to turn this statement into a polemic against banking is despicable.

As for Blankfein’s other statements, it does not seem from what has been written that he is demonstrating the necessary contrition or humility in this particular situation which is going to cast him in a favourable light. Those three words could make him infamous. Perhaps he thought he could speak on the record in his own voice and explain away the bailout followed by the record profits and bonuses. If so, he’s deluding himself – and this piece of biased journalism and the dozens of pieces in multiple languages sheepishly picking up on the ‘God’s work’ part show why.

May the Lloyd be with you. And also with you.

Sample sources

Goldman-Sachs-Chef: "Banken verrichten Gottes Werk" – Spiegel (Germany)

Banker mit Gottes Segen – tagesanzeiger (Switzerland)

Goldman Sachs boss says banks do "God’s work" – Reuters

Topman Goldman: banken doen werk van God – NRC Handelsblad (Netherlands)

Goldman Sachs boss: ‘bankers do God’s work’ – Telegraph

Related posts:

• Goldman’s need to change
• Quote of the day: Investment Bank Leverage
• Bloomberg is coming down hard on Goldman
• Banks: are mergers in the offing?
• Goldman loses $2.1 in the third quarter

For those of us interested in seeing more robust and knowledgeable regulators in government service, the recent news that Rick Bookstaber is joining the SEC is quite welcome. While I disagree vigorously with much of recent economic policy, I view the Bookstaber news as a signal that the Obama Administration is serious about overhauling America’s regulatory infrastructure.

Bookstaber is a market veteran who has a long and storied history of achievement. He worked at Bridgewater Associates, ran the Quantitative Equity Fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management amongst other things.

Here is how Rick put it at his website:

I will be working in the SEC’s new division of Risk, Strategy and Financial Innovation as Senior Policy Adviser to the Director. Here is a brief article and the SEC announcement. We are facing a critical time for defining the future of the financial system; an opportunity for financial reform that comes only once in a generation (if that), and I am excited to be part of this.

I will still be able to write posts from time to time, but obviously with limits on topics and with appropriate disclaimers. How much free time I have to do so, though, remains to be seen.

I won’t be able to publish comments for this post related to the SEC.

Congratulations to Rick. Let’s wish him success is in this important role.

Related posts:

• Guest post: Regulation in Defense of Capitalism
• Guest post: Why do bankers make so much money?
• Bhagwati: The U.S. is underestimating inflation risk
• Ken Lewis is out as Chairman of Bank of America
• Tonight’s US Presidential debate

Related posts:

• News from around the web: 2009-07-27
• News from around the web: 2009-10-11
• News from around the web: 2009-07-31
• Links: 2009-01-19 – banks and bloggers
• News from around the web: 2009-08-02

I have just taken a look at the consumer credit figures for September, released just yesterday by the Federal Reserve. The data do show some modest deleveraging, especially when looking at the recent increase in nominal GDP. However, it is still not clear to me that the scale of deleveraging is great enough to induce a recessionary relapse.

My baseline for deleveraging is Debt to Nominal GDP – when debt to GDP goes down, that shows deleveraging. For example, for the latest data released in September for Q2 2009, Private sector total debt to GDP (incl. financial services) in the U.S. was 292.2% of GDP. Because of the huge drop in nominal GDP, this was actually up from 283.0% when the recession began in Q4 2007. For households, the number was 96.8% in Q2 2009, up slightly from 95.9% at the end of Q4 2007.  What this shows is that deleveraging has yet to begin in earnest as debt levels have remained relatively high even while GDP had collapsed.

The lack of deleveraging is probably a result of financial stress. In the Great Depression, the personal savings rate dropped from 4.5% in 1929 to 4.1, 3.9, –0.9, and finally -1.5% in 1930-1933.  People had to use savings to service debt as the deflationary spiral took hold.

So, in the absence of quarterly data on debt levels, I look at data from things like consumer credit for a proxy.  On a seasonally-adjusted basis, consumer credit declined to $2.471 to $2.456 trillion. That is the lowest since June 2007 and marks the ninth consecutive monthly drop.

However, looking at the non-seasonal data makes plain what is happening:

Nonrevolving credit is now increasing along with GDP. Look at the area highlighted in red; that coincides with the 3.5% real GDP print we just saw. On the other hand, revolving credit is getting crushed. Below is the reason why (click to expand):

Credit from commercial banks and savings institutions have dropped off a cliff.  When you hear people saying that banks aren’t lending, this is what they are talking about. In Q3, banks are lending again (think cash for clunkers) because nonrevolving debt is up.  That’s also why GDP is up. But, revolving credit lines (credit card lines) are being cut.

My conclusion is largely the same as last month, namely I had anticipated more deleveraging than we are seeing. However, consumer credit is only coming down on the nonrevolving side. And given the stabilization in house prices and increases in refinancing activity, I wouldn’t expect mortgage debt levels to be down substantially. When we see Household Debt to GDP levels from Q3, they probably will not be substantially lower than they were in Q2.

This does support recovery but only at the risk of continued high levels of debt to GDP.

G.19 data series – Federal Reserve

Related posts:

• Data on past consumer deleveraging during recessions
• Consumer credit falls 4.4% from year ago levels
• Why is everyone saying consumer credit is falling? It’s not.
• Do the personal income data demonstrate unbalanced reflation?
• U.S. consumer spending down 1% in December

Related posts:

• Links: 2009-04-05
• Links: 2009-05-09
• Links: 2009-01-31
• Links: 2009-01-08
• Links: 2009-03-05

This is classic.

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The Canadian daily National Post has a good piece out today that highlights how the ‘Buy American’ provision is being seen in Canada.  Many see it as an affront that America could and would favor domestic firms over those of its largest trading partner and next-door neighbor despite the North American Free Trade Agreement.

For the second time in six months, pipe fittings in California are being ripped from the ground because they were stamped "Made in Canada," a move manufacturing companies say hurts both sides of the border.

Cambridge Brass Inc., a Canadian brass fittings manufacturer, discovered Thursday that it stands to lose more than $1.5- million in this most recent fallout from the Buy American protectionist measure.

Greg Bell, vice-president of sales and marketing for the Cambridge, Ont., company, received a call Thursday from the City of Sacramento, where the parts were being fitted into the public water system. He was told his product was no longer acceptable because it was not made in the United States.

"It’s disheartening. (The city) wants American-made products and there’s nothing I can do about it," Mr. Bell said. "Business is tough enough these days without having to deal with these roadblocks."

Anything already in the ground will have to be ripped back up at Cambridge Brass’s expense, Mr. Bell said. Between the costs of losing the project, pulling up the pipes and legal fees, he estimates his company stands to lose money in the seven-figure range.

Cambridge Brass has been based in southern Ontario for more than a century and has survived two world wars and the Great Depression, but Buy American may be what finally causes the company to bid farewell to the province.

Mr. Bell said losing a major project like this would mean more layoffs for the already suffering company.

It has already lost a supply distributor in Maine, and it has had to lay off half of its own employees in Cambridge – from a workforce of 140 it is now down to 77 – since the introduction of Buy American policies this year.

And if these protectionist measures continue, he said, the company will likely be forced to move its manufacturing to the United States in order to stay in business.

America seems clueless at how protectionist policies build rage that politicians abroad must quell or heed through retaliation. It’s as if only American politicians want to protect jobs.

It bears repeating because some people don’t get it: it’s not the act of protectionism itself which is so damaging, it is the retaliation and escalation that results.

"The government has got to stand up and propose some serious retaliation," said John Hayward, president of Hayward Gordon Ltd., noting the Halton Hills, Ont.-based industrial-pump manufacturing company has been barred from bidding on U.S. products. He said he has had to switch manufacturing from three Canadian plants to U.S. sites in order to stay in business, a survival decision that has resulted in local layoffs.

Read the full account below.

Source

‘Buy American horror stories’ building – National Post

Related posts:

• ‘Buy American’ will translate into a 21st century Smoot-Hawley
• Canada is furious about U.S. protectonism
• China launches retaliatory investigation into U.S auto subsidies
• The absurdities of ‘Buy American’
• China: we “will take steps to protect the interests of our domestic industries”

Of the five, United Commercial is pretty darn big ($11.2 billion in assets)

United Commercial Bank
San Francisco, CA

As of October 23, 2009, United Commercial Bank had total assets of $11.2 billion and total deposits of approximately $7.5 billion. East West Bank paid the FDIC a premium of 1.1 percent for the right to assume all of the deposits of United Commercial Bank. In addition to assuming all of the deposits of the failed bank, East West Bank agreed to purchase approximately $10.2 billion in assets of the failed bank. As part of the purchase and assumption agreement, the FDIC transferred to East West Bank all qualified financial contracts to which United Commercial Bank was a party and those contracts remain in full force and effect.

The FDIC and East West Bank entered into a loss-share transaction on approximately $7.7 billion of United Commercial Bank’s assets.

Gateway Bank of St. Louis
St. Louis, MO

As of September 25, 2009, Gateway Bank of St. Louis had total assets of $27.7 million and total deposits of approximately $27.9 million. Central Bank of Kansas City did not pay the FDIC a premium for the deposits of Gateway Bank of St. Louis. In addition to assuming all of the deposits of the failed bank, Central Bank of Kansas City agreed to purchase essentially all of the assets.

Prosperan Bank
Oakdale, MN

As of August 31, 2009, Prosperan Bank had total assets of $199.5 million and total deposits of approximately $175.6 million. Alerus Financial, N.A. will pay the FDIC a premium of 1.02 percent to assume all of the deposits of Prosperan Bank. In addition to assuming all of the deposits of the failed bank, Alerus Financial, N.A. agreed to purchase approximately $173.9 million of the failed bank’s assets.

The FDIC and Alerus Financial, N.A. entered into a loss-share transaction on approximately $173.9 million of Prosperan Bank’s assets

Home Federal Savings Bank
Detroit, MI

As of September 24, 2009, Home Federal Savings Bank had total assets of $14.9 million and total deposits of approximately $12.8 million. Liberty Bank and Trust Company did not pay a premium to assume all of the deposits of Home Federal Savings Bank. In addition to assuming all of the deposits of the failed bank, Liberty Bank and Trust Company agreed to purchase essentially all of the assets.

United Security Bank
Sparta, GA

As of September 14, 2009, United Security Bank had total assets of $157 million and total deposits of approximately $150 million. Ameris Bank will pay the FDIC a premium of 0.36 percent to assume all of the deposits of United Security Bank. In addition to assuming all of the deposits of the failed bank, Ameris Bank agreed to purchase essentially all of the assets.

The FDIC and Ameris Bank entered into a loss-share transaction on approximately $123 million of United Security Bank’s assets.

Related posts:

• Seven banks seized by FDIC
• Five banks seized in FDIC Friday night special
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC moves in at Great Basin Bank
• FDIC shuts down Haven Trust and Sanderson State