Archive - Jul 17, 2012 - Story

During an economic boom, exuberance finds itself lodged in all types of industries.  When profits soar, so does the public’s disregard for prudence.  And as tax revenues rise, politicians can’t help but give in to their bread and butter of buying votes.  In the case of a credit-expansion boom fueled primarily by fractional reserve banking and interest rate manipulation through a central bank, the boom conditions are destined toward bust.  Liquidation then becomes necessary as the bust gets underway and malinvestments come to light. What the city of Scranton has in common with San Bernardino, Detroit, et al. is that its dire fiscal condition is due to one thing and one thing only: benefits promised to unionized workers, and, it appears, "the salad days of the government employee are coming to an end, as they have already in Greece, Italy and Spain." To those sick and tired of the tax-eater mentality that is destroying the very core of society’s productive capacity and moral base, those days can’t come soon enough.

Despite the 'idiosyncratic' stresses in California (and elsewhere) the reach-for-'safe'-yield has maintained a strong bid for Munis in the last few weeks (on both a spread and yield basis). As Citi's George Friedlander notes, the last week alone saw 15-20bps compression in the mid- to long-end of the Muni curve - notably outperforming the longer-end of the Treasury curve. New issues have been oversubscribed and snapped as much as 20bps on the break. The reason is simple - 'all-time record' total redemptions (maturing and called bonds) - which left net issuance negative and a strong tendency for certain types of investors to put cash back to work as soon as it is received. However, this flood of 'technical' liquidity from reinvestment faces a rather sudden cliff around the start of August when expected net issuance will turn aggressively positive relative to redemptions. Given the constant refinancings and a lack of maturing reinvestment, Freiedlander expects "the muni market to struggle to absorb [the heavy calendar] after August 1 - and slightly earlier if participants begin to discount this shift", which will only push refinancing costs higher for issuers coming to market.

When it comes to estimating the biggest threat to the global financial system, by far the biggest threat and biggest unknown is the total Financial debt in the system, for the simple reason that as we have been showing for over two years, it is simply impossible to quantify just what the real level of such debt in the developed world truly is, especially when one accounts for shadow liabilities, rehypothecated collateral, derivatives, and all those other footnotes in financial statements that only become relevant when daisy-chained collateral links start collapsing following the default of one or more financial entities, and when gross becomes net. What we can, however, do is show the other three major categories of debt currently existing in the system: Government, Corporate and Household debt, as they are distributed among the "developed" countries. We also know what the tresholds are beyond which the debt becomes unstustainable. In the words of the BIS: "For government debt,  the threshold is around 85% of GDP... When corporate debt goes beyond 90% of GDP, it becomes a drag on growth. And for household debt, we report a threshold around 85% of GDP, although the impact is very imprecisely estimated."

The Fed is caught between a rock and a hard place. If they inflate, they risk the danger of initiating a damaging and deleterious trade war with creditors who do not want to take an inflationary haircut. If they don’t inflate, they remain stuck in a deleveraging trap resulting in weak fundamentals, and large increases in government debt, also rattling creditors.  The likeliest route from here remains that the Fed will continue to baffle the Krugmanites by pursuing relatively restrained inflationism (i.e. Operation Twist, restrained QE, no NGDP targeting, no debt jubilee, etc) to keep the economy ticking along while minimising creditor irritation. The problem with this is that the economy remains caught in the deleveraging trap. And while the economy is depressed tax revenues remain depressed, meaning that deficits will grow, further irritating creditors (who unlike bond-flipping hedge funds must eat the very low yields instead of passing off treasuries to a greater fool for a profit), who may pursue trade war and currency war strategies and gradually (or suddenly) desert US treasuries and dollars. Geopolitical tension would spike commodity prices. And as more dollars end up back in the United States (there are currently $5+ trillion floating around Asia), there will be more inflation still. The reduced global demand for dollar-denominated assets would put pressure on the Fed to print to buy more treasuries.

When the Fed released its "trove" of materials confirming that the Fed indeed knew that the Barclays was manipulating its Libor submissions (amusingly explained by Ben Bernanke before Senate today that "the employee had no idea what Libor is in that case"), few were surprised, but more were confused why the congressional inquiry focused solely on the Fed's interactions with British Barclays, instead of focusing on the three domestic banks that were part of the BBA's USD Libor fixing committee.Sure enough, the 3 US banks on the USD Libor fixing committee were just dragged into the fray: "Representative Randy Neugebauer, a Texas Republican and chairman of the oversight and investigations panel of the U.S. House Financial Services Committee said he intends to request correspondence between the Fed and the three U.S. banks on the Libor-setting panel, JPMorgan Chase & Co. (JPM), Citigroup Inc. (C) and Bank of America Corp., according to a congressional aide, who spoke on condition of anonymity because the details were not yet public."

Whitney Tilson may have met his match. Canadian commodities hedge fund Salida Capital is no stranger to media notoriety: last October none other than Zero Hedge wrote that "Fund Blamed For Gold Sell Off, Salida Capital, Tumbles 37% In September, 49% YTD" after the fund's infamously timed bet on more easing by the Fed backfired and resulted in losses so severe it was enough to warrant liquidation rumors across all commodity classes, which in turn set off follow on liquidations worries in a self reinforcing feedback loop. In retrospect, anyone who read the caveats about the Toronto-based asset manager would have been wise to get the hell out of dodge, because the firm that simply had used massive amount of leverage to generate ridiculous returns such as +35.84%, -66.50%, +188.55%, 44.88%, and -53.39%, is now down 75% in the last 12 months, meaning anyone who invested $100 with the fund, is down to just $25 (and realistically less when management fees are accounted for). It also means that the fund's Sharpe ratio is borderline negative. Finally, it is precisely such fantastically leveraged contraptions on coin toss-based outcomes that even further undermine what little credibility and standing the last vestiges of real, alpha not beta-focused, asset managers remain in this New Normal of ubiquitous central planning.

Wealth has become stateless, and as a consequence it is becoming increasingly less accountable to any state’s laws or tax codes. Over the last quarter century it has become increasing easier to transfer large sums of money, what is more, large financial institutions find it far easier today to relocate to a different legal and tax jurisdiction than at any previous time, because it is easier to re-establish the necessary business infrastructure, the cost of relocation has lessened. Recognising this trend over the last quarter century, and being desirous of any slice of revenue they can get their hands on, governments around the world have competed with each other, to provide the ‘best business environment’ for those financial institutions. Let’s not delude ourselves about this, the ‘best business environment’ is the least regulation and the most advantageous tax breaks. And by competing with each other in this way, governments around the world created the regulatory environment which was, in part, responsible for the current financial crisis. And then there are the ‘Tax Havens’

The sad 'this-is-how-politics-works' punchline of this brief animated clip is "those who can afford political influence get the benefits; and those who cannot afford it suffer the consequences" as Professor Matt Zwolinski attempts to balance the question the common claim that 'capitalism exploits the masses for the benefit of the few' - implicitly advocating increased government power - by suggesting (shock, horror) that government power may be more exploitative than free-market capitalism. In just over two minutes, Zwolinski argues that bigger government (thanks to cronyism among other things) makes citizens more vulnerable to exploitation given its power to coerce - intriguing given the recent comments by Obama.

It may be blasphemy but we ask "Is a Eurobond necessary?" UBS' Paul Donovan suggests the short answer to this question is “no”. The long answer is “no, of course not, not like this”. The Euro area seems to have drifted into something of a fiscal backwater with the debate over Eurobonds. German Chancellor Merkel has rather melodramatically declared that Eurobonds will not be an option as long as she lives. As Donovan notes, European politicians go back and forth over the merits, necessity, and preconditions for Eurobonds. He sees this as "a waste of time". Eurobonds are not a necessary condition for the survival of the Euro, even though (in our view) fiscal union in some form is a necessary condition. The Eurobond debate is diverting valuable political and economic resource into what is at best an irrelevance, and at worst may actually undermine the stability of the Euro area.

Getting paid miserable wages? Don't fret - just buy the stock of your (hopefully public) employer, and hope and pray that this time is different, and that light at the end of the tunnel is the not the next latest and greatest (and likely last) stock market collapse, in the ultimate trade off of current pay for capital gains: 13 quarters in and Labor Comepnsation is still lower than where it was when the Great Financial Crisis began.

Equities managed to rally after slumping on heavy volume to the 1340 level (scene of crime for Greek election, Spanish bailout, and EU-Summit) pushing up to close at the mid-June swing high levels and post EU-Summit close levels around 1358 (back over its 50DMA). Total volume for the S&P 500 e-mini (ES) was just below average but the average trade size was dismal - around the lowest of the year. Whether due to VIX options expiration squeeze sending VXX and other derivatives tumbling (with VIX almost testing a 15 handle intraday); or a safety 'algo' running things up and over VWAP; or a reflexive reaction to bad is good and Bernanke has our backs no matter what happens, equities pushed 20 points off their lows but stagnated for much of the afternoon. The surge in stocks far outpaced risk-assets and what was more worrisome was the notable divergence in gold as the afternoon wore on - if this was QE-hope then the main QE-sensitive asset class of choice was not playing along at all into the close. Gold and Silver ended the day down modestly, Copper worse, but WTI ended the day up 2.3% on the week and back over $89. Treasuries pushed higher in yields (oh yes very QE-on?) - no higher in yield on the week with the long-end underperforming. FX markets were a little more aggressive - like Treasuries - and extended their rallies relative to USD with AUD now up almost 1% and the USD now down 0.36% on the week - which is interesting given Gold is also down around 0.5% on the week.

INTC missed the Q2 topline ($13.5 billion vs Exp. of $13.54 billion), even as it met bottom-line estimates of $0.54, but it is the company's forecast for 2012 that has caught traders off guard, because the technology company is merely the latest one to revise its outlook for the year lower. To wit: "Revenue up between 3 percent and 5 percent year over year, down from the prior expectation for high single-digit growth."

The public pension and retirement 'schemes' are in considerable trouble (as we noted here and here) and now, according to a recent S&P study, private companies are at record levels of pension under-funding. Fiscal 2011 shows that the under-funded level for S&P 500 companies' defined pensions reached an epic $354.7 billion - an increase of over $100 billion from 2010 and surpassing the 2008 record of $308.4 billion - and OPEB under-funding reached $223.4 billion. An aggregate $578 billion or 29.5% underfunding or the $1.96 trillion in obligations is increasing as the rates of return are reduced thanks to yet more unintended consequences of the Fed's ZIRP and perhaps most worrying is there comment that "The American dream of a golden retirement for baby boomers is quickly dissipating; plans have been reduced and the burden shifted with future retirees needing to save more for their retirement.  For many baby-boomers it may already be too late to safely build-up assets, outside of working longer or living more frugally in retirement."

The head of now bankrupt futures brokerage PFG may not have been very successful when it comes to executing succesful suicide attempts, but when it comes to spending stolen client money over a period of two decades he had few equals. From the WSJ: "Peregrine Financial Services Inc.'s founder said he spent most of the money allegedly embezzled from customers to cushion his futures brokerage's capital, fund a new corporate headquarters—and to pay regulatory fines and fees, according to previously undisclosed parts of a suicide note and signed statement." It also appears that it was all the regulators' fault: "Most of the misappropriated funds went to maintain the increasing levels of Regulatory Capital to keep [Peregrine] in business and to pay business [losses]," said the signed statement, which was reviewed by The Wall Street Journal. The statement says the misappropriated customer funds also were used to build Peregrine's headquarters in Cedar Falls, Iowa, and to "pay Fines and Fees charged by the regulators." So... to summarize... the guy who stole money for twenty years, stole it only to comply with regulators requirements for compliance... Now that does not compute.