Rick Wagoner VS Ken Lewis

Rick Wagoner got sacked. The order to fire him came straight from the White House. We have not seen that very often in US history. Possibly Mr. Wagoner deserved to get the boot. He worked pretty hard, he made progress on a lot of GM issues. Five years ago the stock was trading at 60 and the bonds looked money good. What Mr. Wagoner failed to do was to anticipate a 50% drop in annual vehicle sales from the 2006 levels of 16mm units sold to a lousy 8mm running rate so far this year. No one could have predicted that unprecedented drop in demand. If Mr. Wagoner had proposed a plan to his Board two years ago that anticipated the future more accurately the Board would have sacked him on the spot. Damned either way.


If Mr. Wagoner is to be held responsible for the collapse of the economy and its effects on GM one has to wonder what other CEO may come into the government’s cross hairs. Ken Lewis of Bank of America has to be high on that list. If the decision were to be up to the numbers Mr. Lewis has a problem.

GM has taken 14 billion of TARP money. GMAC has another $5 billion from the Fed. The GMAC side of this will probably work out. What is at risk is the $14 billion.

Bank of America on the other hand has taken $45 billion of TARP funds. There is talk from Mr. Lewis that some of this may be paid back. Do not hold your breath. BAC’s first quarter is going to look ugly.


GM reported a loss of $31 billion for the year. That gets you your walking papers.

Mr. Lewis reported a gain for the year. He noted in his year end remarks that for the year BoA had capital market losses of $10 billion and $27 billion in credit losses. Credit losses are likely to rise for the next year. As for that ‘Full Year Profit”, well, wait for the 1st quarter report. The $2.4 billion loss in the forth quarter does not include the full impact of the Merrill legacy positions.

Mr. Wagoner bet the ranch on an electric car. That seemed like a good idea when oil was 200% higher. As for Mr. Lewis, time will tell if his purchases of Country Wide and Merrill were so smart.

The point of this is not that Mr. Lewis should get the axe. He should not. If we are going to fire everyone that misjudged the developments of the past 18 months there would be very few CEO’s still standing. At this point America needs Ken Lewis more than Ken Lewis needs his job.

The market fell by 3% today. The talk was that the GM news was to blame. Bunk. The idea that GM is going to file a chapter any day has been in the market for weeks. Just look at the pricing on the bonds. What scared the money today was the strong-arm tactics of the White House. The growing concern is that we are spending $3-4 trillion to ‘preserve’ what we had, but at the same time were are tearing down everything that we thought was worth preserving in the first place.

Social Security Trust Fund - The Mother of all Bond Portfolios

The G20 will certainly discuss the matter of Reserve Currencies this week in London. There is a lot to discuss on this topic. As of January 09 the US Treasury reports foreign holders of US Treasury securities (excludes Agencies) of a total of $2.399 Trillion. The biggest holders of these securities include:


While those numbers in the aggregate are staggering they are nothing compared to the biggest holder of Treasury Securities. As of January 2009 the Social Security Trust Fund (“SSTF”) held $2.419 Trillion of Treasury Obligations.

Fortunately for Mr. Geithner at Treasury and Mr. Bernanke at the Fed the SSTF is a captive buyer of Government paper. Unlike the Chinese the SSTF does not have the option of diversification. Also unlike the Chinese they can't complain about the risks they are taking while investing such an enormous amount of money in the IOU's of America.

The SSTF provides a significant amount of information regarding their holdings on their web site. For those that love to analyze huge data bases this is a place to spend an afternoon. For those bond traders out there, the information contained in the various reports will surprise you. The SSTF publishes a blotter of all of it's transactions. There are some links at the end the end of this article.

This observer has reviewed the information. It is difficult to draw definitive conclusions, there is just too much to look at. The following are observations based on a review of the data and related information.

*The mission of The SSTF is to invest all of it's excess cash while at the same time maintaining sufficient liquidity to meet its monthly disbursements. The numbers are very big. The April 2009 SS checks will total $55 billion. The SSTF has a big 'cash management' job as their in/out flows are very seasonal.

*The investment activity of the SSTF is governed by a law enacted in 1960. At that time a 'formula' was established to determine the pricing of securities that would be purchased by the SSTF from Treasury. There are two forms of securities, One short term, the other long term. The short term is defined as a maturity of one year or less. All short term securities mature on the next June 30th. The long maturities range from 1-15 years.

*The 1960 law was a reasonable effort to establish rules for these purchases and sales. However it is archaic in 2009. It causes the SSTF to do all manner of things that would seem illogical. One consequence is that there are huge swings in the 'fair value' that is conveyed from the taxpayer to the SSTF each year.

*The pricing formula is simple. The average of all the Treasury coupons for the prior 30 days is established on each June 30th. The rate for all maturities is set at this one average rate. The following is a description and pricing of these new issues. The amounts are in billions.


When the yield curve for 1-15 year maturities is steep the average pricing formula from 1960 produces a significant variance to the results that would have been achieve if 'market' rates had been applied to these investments. The consequence of the formula is to produce interest rates on short maturities much higher than the prevailing market rates. However, the formula also produces a lower than market rate for the all important 15th year maturity.

The ratio of 1-14 maturities to the 15th year is about 12 to 1. Therefore understating the yield on the 15th year portion significantly reduces the cost to Treasury overtime. The following are my calculations of the differences for selected years.


The large variance between the 1960 formula and the results that would have been achieved if market rates were applied sets up an interesting debate. The Grey Panthers want 'market rates' and anyone under 40 wants to keep the old formula. A curious juxtaposition of interests.

*In January of 09 the Fund bought a net of $18 billion of Treasury notes due in five months at a yield of 2 1/8 %. The market yield on that date for this would have been closer to 90 BP's. This one transaction represents a scalp of the Treasury for $90mm. One wonders if anyone is looking at this.

*In 2008 the SSTF bought and sold securities in excess of $2 Trillion. Approximately equal to their portfolio size. This is a surprisingly large number given they are executing the classic buy and hold strategy. A substantial portion of the buying/selling is a result of the requirements of the 1960 rules. The SSTF is stuck with rigid investment guidelines. The rules conflict with their requirement to have funds invested while at the same time managing the monthly cash outlays. This observer is convinced that there is a 'better way'. Cash management techniques have evolved a great deal in the past fifty years.

*There appears to be discretionary activity in managing the portfolio. Choices appear to made in some years and different ones in other years. It begs the question, Why?

In the second half of each year the SSTF redeems certain securities and replaces them with new securities. All of the securities that are bought and sold have maturities of the next June 30th. The result of this buying and selling is not clear. The value of the portfolio as of the next June 30th is not affected by this activity. However, this activity does have an affect on the reported year end number put out by the SSTF. In some years the fund sells high coupon notes and replaces them with low coupon notes. This produces a capital gain which would increase the YE number. In other years they do the reverse.

By my calculation the result of their activity in 08 was a gain of $197mm. Their activity in 07 produced a loss of $117mm. No doubt this is a random event that happens when running such a huge pile of money. They did however choose the bonds to be redeemed deliberately.

*The April 2009 cash outlay for SS will be $55.7 Billion. The average annual rate of increase in the last five years is 6%. That number jumped up in January of 2009 to a YoY increase of 9%. The jump in expenditures means about $150mm a month to the Fund. This sharp increase in 09 is a reflection of America's election cycle.

*The actuarial at the SSTF says that it is “80% probable that assets in the fund will begin to decline later than 2013”. This is not a date when SS is broke. That occurs far into the future. The 2013 date is however significant to the US Treasury. From that point onward the SSTF will not have excess cash to invest. This means that this constant buyer of US debt will go away. The fund currently holds $2.4 Trillion. This means that they have funded 1/3 of all the deficits since 1938. As a buyer of new Treasury issues they will be sorely missed.

The dynamics of the fund are driven by prevailing interest rates, economic activity and the rate of expenditures. In 2009 interest rates are low, economic activity is low and the expenditures are increasing on a cash basis by 9% annually. That 80% probability for 2013 is at risk. Either way 2013 is not very far away.

*The SSTF invests in a strip of Treasury maturities from 1 to 15 years. There is a ratio of the amount of intermediate maturity bonds and the final maturity of the bond. That ratio varies from year to year. In the 1990's that ratio averaged 14%. In 2000 it started to decline. In 2008 it stood at only 8%. This change in investment strategy would seem to be motivated to create duration. The significant change in this ratio suggests that 'human' choices are being made. While extending duration my be a wise choice it is still a choice. On Wall Street they call this a “rate bet”.

*The Fund produced this graph which shows the ratio of those employed and contributing to the fund versus the number who are receiving benefits. That number began a permanent decline in 2007. About the same time that everything else fell apart.



Links of interest:
http://www.ssa.gov/OACT/ProgData/investheld.html
http://www.ssa.gov/cgi-bin/transactions.cgi
http://www.ssa.gov/OACT/ProgData/intrateformula.html

America's 'Best Sellers' List

America leads the globe in matters of diabetes, heart disease and obesity. Clearly our problem is our diet. We are what we eat.

America is also a global leader in creating boom and bust cycles. It is unlikely that our poor eating habits are responsible for that. The nation's 'Fast Buck' mentality is best reflected in what we read. If our physical health is driven by our diet then our economic well being is driven by our reading habits.

Some recent Best Sellers:























tks emmy.

China's Big Threat

You have to wonder what China is really thinking about regarding the dollar and it holdings of US securities. The Chinese have their own set of issues at the moment. One would think that they realize it is not in their best interest to destabilize the global capital markets at this point in history.

Last Friday Chinese Premier Wen Jiabao was quoted saying:

“We have lent a huge amount of money to the US. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried."


Again yesterday another shot over the bow from People's Bank of China Governor Zhou Xiaochuan:

Our goal is to, "create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run."


This is a high stakes game they are playing. The timing of these two announcements is not a coincidence. They are teeing this issue up in the press one week before the global summit in London. How far are they prepared to go with this?

Treasury Secretary Geithner reacted with a flip flop that caused the dollar to gyrate by 1.3% in under a half hour. He first commented:

“We’re actually quite open to that.”

Apparently some aide whispered in his ear that the dollar was getting hit so he added:

“I see no change in the U.S. currency’s role.”

There were reports that several of the big trading houses earned a months wages in those 15 minutes. Good for them. A tad sloppy on Mr. Geithner's part.


Consider the absolute worst case scenario.

Bank of China head, Xiaochuan calls Geithner and says, “We want out”.

Cool headed Geithner would respond, “Let me get the report of your holdings”... “I have it. As of today you own $1 Trillion of US paper. It is held in Treasury bills notes and bonds. You also have Agency paper and RMBS that is guaranteed by the Agencies. You want to sell it all?”

Mr. Xiaochuan would respond, “Yes, that is our intention. We will sell our bond holdings for cash and then convert the proceeds into non-dollar currencies. We will acquire sovereign credits of those countries. The diversification program will result in holdings of 10% Canadian, Australian, English and Swiss Currencies, plus 20% of Euros Yen and the Dollar.”

In the tradition of Wall Street Mr. Geithner would respond, “Hold the phone.”

This exact situation has been the subject of discussion for many years. The working assumption has always been that something along these lines would happen sooner or later. Enormous Central Bank to Central Bank swap lines are in existence today to handle this situation. The conclusion has been reached long ago that the US dollar and US Treasury are 'too big to fail'. Decision makers at the Group of 7 Central bankers are almost always available in emergencies. They could convene in short order and agree to provide the necessary swap facilities and currency repo lines to the US Treasury. Each of the Central banks will reap some benefit from providing the necessary credit.

Follow the money. China has US IOU's and wants cash so it can buy foreign currencies. Treasury does not have this cash but has the swap lines. Treasury borrows $800 billion from the 6 Central Banks. China gets the $800 billion and gives it directly back to the same 6 Central Banks in exchange for their respective currency. China uses this currency to buy Government debt securities from those same Central Banks. The books of the Central Banks are all a wash. The have new assets and liabilities, but they did not have go to the market to fund these new assets. The money came to them. While these types of transactions are not desirable they do create a situation for the foreign Central Banks where a huge slug of new capital is invested into their economies. They are required to re-lend these funds back to the US on a temporary basis. That activity should result in a net gain or savings to the participating Central Banks. All in all this would be a net plus to them.

This would be a blow to the US. But not a crisis. Treasury would be forced to absorb the risk and rewards of borrowing under the currency swap facilities. Offsetting this would be the reduced interest costs realized by funding short term at Libor rates versus the long term spreads the Chinese are currently realizing.

Mr. Geithner could get back on the phone with Mr. Xiaochuan and say, “We are prepared to put a price on the whole thing. We will use Bloomberg mid-day rates for both the bonds and the currencies. We will charge 1% on the bonds and an additional 1% on the currency conversions. If you want to come in through the markets go ahead. We will just bid for what you are selling under the market. If you do it our way it will save you money.”

Of course nothing like this will ever happen. The point is that the Chinese threat has an existing solution. That fact makes it all the more likely that China will not make good on its threats. In the end it would cost them a great deal. They would have achieved the desired currency diversification but that merely creates a different set of risks.

The Chinese threat to diversify its holdings is a real, but manageable. This observer would not be surprised to see this issue simmer down. It would be helpful if Mr. Geithner would treat his largest existing investor with a little respect. It is possible that this whole issue has been brought to a boil as a result of the Treasury Secretaries comments at his own confirmation hearing in January:

In a written submission to the Senate Finance Committee, Mr. Geithner said "China is manipulating its currency."





Financial detente should be an objective of the April 2 meetings in London.

FHFA's Lockhart on Home Prices – Everything is Fine

The Federal Housing Finance Agency issued a very up-beat report today on housing prices throughout the United States for January of 09. Their report showed a country-wide increase in home prices of 1.7%. The Biz TV channels broke in over the now daily Geithner/Bernanke hearings to tout the good news. No doubt there will be some 'strong buys' on the homebuilders to follow. Before jumping too deep into the celebration one should look at the FHFA report in its entirety.

FHFA provides a few caveats to their number:

Month-to-month changes in the geographic mix of sales activity explain most of the unexpected rise in prices in January. The January home sales reflected in the FHFA data disproportionately occurred in areas with the strongest markets.

The estimation imprecision associate with the January estimate is relatively large and subsequent revisions to the monthly number could be significant.

There could not be a better time for these 'random variations' in the data to produce a blip in the numbers. This observer does not think that the FHFA is juicing the numbers. They are just using bad data.

Case-Shiller (“CS”) produces a different report on home values. The two reports are not truly comparable as the CS report measure cities and FHFA reports on regions. The two reports somehow mange to reach different conclusions on the status of the housing market in the United States over the past year. For example:

The FHFA reports price drops in the South Atlantic Region at 8.3%. CS reports a drop for Miami of 29% and for Tampa a drop of 22%. Three times as large as FHFA.

The FHFA reports New England down a scant 2.2%. CS on the other hand shows Boston dropped 7% while NY was down 9.2%.

FHFA reported a whopping drop of 21% in the Pacific Area. CS reports Los Angeles -26%, San Fransisco -31% and San Diego -25%. The folks on the West coast of the United States should take issue with the FHFA. The Pacific Region constitutes 40% of the country's real estate after all. A clear flaw in the way FHFA aggregates this data.

FHFA reports the East South Central region as down a modest 1.4%. Tell that to the folks in Atlanta. CS reports a 12% drop there.

Across the entire spectrum of data the FHFA consistently understates the extent of the damage in the real estate market. That is not surprising as they have been soft peddling the problems from the start.

Mr. Lockhart you are the boss of FHFA. This means that FNM and FRE are on your table. These entities went into receivership two months after you said they were "adequately capitalized". You currently have 1.2 mm borrowers 60 days past due. That number has been growing by 75,000 a month. You can only restructure 10,000 loans per month. You have a ten year backlog of loans to restructure. The $200 billion that Congress has allocated you to keep the Agencies afloat is functionally exhausted. This disaster could not have happened with the modest decline in home prices that you have reported. The CS report is much closer to the truth. The losses the Agencies have already suffered and the additional losses embedded in their books is all the evidence you need to know that your report understates the level of the declines.

Mr. Lockhart you somehow survived the transition from Bush to Obama. Given the circumstances at the Agencies during your tenure as the top cop that comes as a surprise. But you made it. With this transition came a promise of openness and candor. The American people desperately need some candor.

Geithner's Proposal - A Closer Look

The markets loved Geithner's plan. The talking heads touted it all day long. The market wanted an excuse to take a leg up and this was it. Possibly it was just the sense that, “They are finally doing something” that got the money flowing. This observer is not so excited.

Mr. Geithner's approaches to today's problems are reflective of his predecessor, Hank Paulson. The history books will give Treasury Secretary Paulson an A+ for keeping his fingers in the ever increasing number of cracks in the financial dike. His actions bought the next administration a small window of time to address some very big problems. Mr. Geithner is still trying to plug leaks. He has no plan to stop the rise in the water behind the levee, nor does he have a plan to truly shore it up. He is offering us more of Mr. Paulson's sand bags.

The Alt A and Sub Prime totals are in the range of $1.4 Trillion. The much larger Prime mortgage market is also stressed. Of the $12 Trillion of mortgage assets currently outstanding there is at least $2 Trillion of troubled loans. The toxic side of credit card paper coupled with bad car loans is another $1 Trillion. Then you have the commercial real estate side of the equation. An estimate of $1 trillion of questionable assets in this category would seem low. Finally there is the Commercial and Industrial loans. There is a tremendous amount of these C&I loans that are currently trading well below their par value. Add another $500 billion. There is at least $4T of paper that is looking at Mr. Geithner's $500billion bid. Talk about an order imbalance.

The most likely result is that very little will be accomplished other than the movement of some of the deck chairs. A year from now the system will still be overburdened with the Legacy Assets.

From reading the Treasury proposal one gets the sense that Mr. Geithner went to Wall Street and asked the question, “What will it take to get a deal done?” Wall Street may be bruised but it is not stupid. The obvious answer to Mr. Geithner's plea was, “If you put up most of the equity and all of the debt and agree to pay us humongous fees we might be able to get some of this done”. Bill Gross of PIMCO said this evening that the plan was a “win win”. Mr. Gross might just win twice on this deal.

Some comments from the Treasury press release:

“The excessive discounts embedded in some legacy asset prices are now straining the capital of U.S. financial institutions, limiting their ability to lend and increasing the cost of credit throughout the financial system.”

Read this sentence to mean: If the banks were to use the current market prices to mark their assets they would be out of business. Therefore our strategy is to artificially raise the price of these assets so that the banks can afford to liquidate their bad books. Our plan is to 'buy high' and hope for the best.

"Using $75 to $100 billion in TARP capital......."

It is troubling that they would provide a range of the equity they are prepared to commit. One has to wonder if the uncertainty is based on the lack of clarity as to the success of the program, or is this just a lack of funds in the remaining TARP II? Either way it is a drop in the bucket.

"Maximizing the Impact of Each Taxpayer Dollar: By using government financing in partnership with the FDIC and Federal Reserve..."

The taxpayer puts up a buck in equity and the Fed and FDIC supe it up with debt. Isn't that how we got into this mess in the first place?

Treasury 'steps' in the process:
Step 4: Of the purchase price, the FDIC would provide 86% of the financing, leaving 14% of equity.
Step 5: The Treasury would then provide 50% of the equity.
Step 6: The 50% private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis.

Some additional 'steps” that were not mentioned:

Step Backward 1: The fees paid back to the investor will be the standard 2% per annum. These fees allow the investor to amortize it's investment in the fund over four years. This is an old Wall Street trick. You earn your equity position, you do not pay for it.

Step Backward 2: The deal gives control of asset dispositions to the 'investor'. By the fourth year they are money good on this deal and will want to cash in their free equity. This puts the manager in a potential conflict with the Treasury's interests. Never a good plan.

Step Backward 3: 93% of the capitalization for the deal comes from the State. That is not a sale. That is a joke.

"Joint Financing from Treasury and FDIC:..."

Just a few questions here. If this money is coming from Treasury and at the same time Bernake has promised to buy Treasury paper does this mean that the money for all this is just being printed? When did the FDIC get unlimited authority to guarantee the indebtedness of a SPIV?

More Treasury 'steps'. This time regarding the securities side of the proposal:

Step 6: The fund manager has full discretion in investment decisions. If the fund manager so determines, they could take advantage of the TALF program.

This means that a minority investor who wants to vote with his feet can force a sale of assets back to TALF. This provision is simply not in the public interest.

"The Merits of This Approach: The plan reduces the risk of prolonging a financial crisis, as in the case of the Japanese experience."

Those are fighting words Mr. Geithner. One should never pick a fight unless there is certainty as to the outcome. You have created the ammo to deal with about 20% of the problem. This is looking more and more like that 'Japanese experience' you are trying to avoid.

AIG versus America

Every talk show and newspaper focused on the AIG story this weekend. The discussions all circled around the problem of the $165mm of bonuses. This is a side issue. The real problem is that the disease that has infected America has its roots in the business practices of AIG.

In Congressional testimony this past week AIG's beleaguered CEO Edward Liddy said that it could take up to four more years to unwind the remaining 1.6 Trillion CDS book that AIG is dying under. Good luck Mr. Liddy. This writer believes that you and AIG have less than four months before the lights go out. The American people hate AIG. They do not want to do business with this company any longer. Congress hates AIG too. Fed Chairman Bernanke has said on TV that he 'hates' what AIG has done. This busted company has no friend in Mr. Geithner either. The life line of support they are hanging by is very tenuous.


Lost in the weekend's debate over bonuses was the following story:

American International Group Inc's (AIG.N) United Guaranty Mortgage Indemnity Co sued Countrywide on Thursday in a California federal court, contending that the lender had misrepresented risks tied to more than $1 billion of mortgage loans that United Guaranty insured.

The case was filed a day after Countrywide sued United Guaranty in California state court in Los Angeles. Countrywide said United Guaranty was trying to get out of its obligations to provide insurance coverage.

If the times were not so serious these lawsuits would be laughable. Here's what the suits area about:

-Countrywide Financial was the poster boy for originating sub prime loans. No document, liars loans with loan to values in excess of 100% were their speciality.

-United Guaranty, with the backing of AIG was trying to build market share in the high risk mortgage market. They aggressively priced and wrote insurance risk on the top 20% of the bad mortgages that Countrywide was creating. They were paid well for assuming this risk. They knew that these were very high risk loans.

-With the AIG first loss insurance the mortgages were sold to Fannie Mae and Freddie Mac. In 2008 over 22% of FNM's book of loans have been 'enhanced” by the likes of AIG.

Every aspect of this collapsed in 2008. Countrywide was sold to Bank of America (a purchase that Mr. Lewis now regrets.) The default rates on the enhanced loans exploded. The Agencies suffered losses on the mortgages in excess of the insured amounts. When the Agencies seek reimbursement from BAC for the insured amount owed to them they are told that AIG is reneging on its promise to pay. Thursday's lawsuit and counter lawsuit are the result.

What is the certain outcome of this? The answer is that some combination of this sad list of characters is going to take a hit of at least $200 million in extra losses. Either BoA, AIG, FNM or FRE are going to take the losses. Given that Uncle Sam owns or controls the lot of them it is certain that the taxpayer is going to once again have to pony up.

UGI announced it's operating results a week ago. They reported losses of $2.48 Billion for the full year 2008. 100% of those losses were born by the tax-payers.

Fannie Mae recently reported that its default rate on 'enhanced' loans was five times larger than the default rate on loans with the traditional cash 20% down.

By now everyone understands that this is just bad business. Everyone is losing because of it. Yet this practice is continuing today.

On March 16, 2009 United Guaranty revised its standards for providing the first loss insurance that has caused so much pain. Their new standards are significantly more restrictive. The new terms are condensed* as follows:


Noteworthy is the fact that 95% mortgages are still available in 'Moderately Declining Markets'. That AIG is still providing 90% mortgages in 'Severely Declining Markets' is troubling. The loan caps are equal to the Agency's limits. One can be certain that the loans originated under these programs will end up in either Fannie Mae's or Freddie Mac's inventory in the next few months. The fact that AIG is continuing to expose the taxpayer to high risk mortgage lending and is contributing to the losses at the Agencies is much more significant than the problem with the bonuses.

The availability and terms of Private Mortgage Insurance should be regulated by the state insurance commissioners. No company that has received TARP funds or that is in Government receivership should be allowed to write PMI or invest in loans enhanced with PMI. If Mr. Bernanke and Mr. Geithner are serious about restoring faith in the credit market then they have to preclude AIG, Fannie Mae and Freddie Mac from participating in high risk mortgage lending.


As of today AIG has an unused credit line from the Federal Reserve for an additional $30 Billion. If Mr. Bernanke is called upon to sign another big check he risks a backlash that could taint his tenure If he were to seek the consent of Congress today he would not get it. AIG's days appear to be numbered. If that is to be the case one has to wonder what will happen to that $1.6 Trillion CDS book that has caused all of these problems.

*Link to the AIG – UGI information:
https://www.ugcorp.com/rates/EligibilityGuidelinesSummary_03-16-09.pdf

S&P on GE - A Rosy Outlook?

GE's stock has been on a tear since March 12. That was the day that S&P downgraded GE by the narrowest of margins. From a AAA to a AA+. The stock hit $11 earlier today. Up almost100% since the S&P review. Jeff Immelt tried everything he could to talk up the stock for weeks. He got no respect. But when S&P speaks the market still listens. The market liked the fact that S&P felt it was only necessary to drop GE by a half a notch. It was pleased as punch over the 'stable' outlook.

The March 12, 2008 S&P report on GE was written by Robert Schulz and Scott Sprinzer. These two have been writing on GE for years. They are also very knowledgeable about the major banking institutions. Their history is rating the car companies. These guys know it all. No wonder the stock rallied.


This writer is not so sanguine about GE's prospects. But, what do I know? Schulz and Sprinzer are the experts. Here is what they said in their report:

“We do not anticipate that GE will benefit from any meaningful earnings or cash flow from GECC through 2010."

What? No expectation of earnings or cash flow from GECC? An average of 37% of GE's consolidated earnings came from GECC in 2007 and 08. Just under $21 billion over the previous 24 months. GECC is the largest single contributor to GE's earnings. That number is going to '0' for the next twenty months? That sounds material to me.

On the all important matter of cash flow for GE S&P commented:

"We believe that GE's industrial businesses will generate about$2 billion in discretionary cash flow (after dividends) in 2009 and a significantly greater amount in 2010, aided by the 68% reduction in the common dividend that the company recently announced."

This does not make me feel better at all. The 68% savings they refer to is actually $9 billion. So the amount of the 'discretionary' cash flow that S&P is relying on is a meager $11 billion over the next 21 months. For GE that is small beer. With their $685 Billion balance sheet this cushion amounts to less than six months of interest expense. $11 billion is approximately 20% of the commercial real estate exposure that Mr. Immelt “wishes he did not have”. GE's fixed charges in 08 were $110 billion so this amount only covers a month or so of the cost base. GE's income statement reports 'Other Costs and Expenses” of $42 billion for 2008. This cushion S&P is relying on is just a fraction of that.

On the matter of the balance sheet S&P is pretty up-beat:

"The company's ample financial flexibility should continue to support the ratings at the current level and the stable outlook."

On this point I am going to respectfully take issue with Mr. Schulz and Mr. Sprinzer. GE needs $20 billion of equity. To sell that much common would require a 25% increase in the float. The dilution will kill the existing shareholders. There is no way that GE can sell this much common. GE's Preferred stock has recovered to 8% this afternoon. Big deal. This company has no divisions that are earning 8% cash on their equity. Fixing the balance sheet hole with expensive pref stock is also not a realistic option. The bottom half of the balance sheet does not appear to have much of that “ample flexibility' S&P refers to.

The debt side is also troubling for GE. They have been very successful in issuing medium term bonds in the past few months. However, every one of those bonds was guaranteed by the FDIC. Let's be clear on this issue. The capital markets are not working for GE in 2009. In the past six months the collapse of the credit market nearly brought GE to its knees. There was a point in this crisis that GE was totally dependent on the Federal Reserve to buy their short term commercial paper. Without the credit guarantees from the FDIC GE would not have been able to sell its notes at a reasonable cost. It would appear that S&P is assuming that Washington is going to provide that 'flexibility' that GE so desperately needs. This is a dangerous assumption to make given the rapidly changing mood of the Nation on this broad topic.

I for one would take issue with the S&P ratings for GE. I would have preferred a “fresh” voice on this extremely important ratings call. This would have been more in keeping with S&P's Ombudsman, Ray Groves' policy regarding rotation. Certainly I would have liked to see some disclosure regarding S&P's overall relationship with GE. After all, S&P is currently rating 50 different GE securities and they appear to be one of S&P's largest clients.

GE reported today that they have 'Stress Tested” the company to a level where unemployment rises to a peak of 10% and aggregate GDP falls by 3%. By the end of this year those numbers will look good. There is nothing stable about the outlook for GE. For those that got that warm and fuzzy feeling from the S&P report, beware.

Bernanke's Bunker Bomb

It was a Biblical day in the markets. Big winners, big losers. Gold traded peak to trough for 52 bucks. The ten year Treasury bond yield fell by 50 basis points. On a price basis it was the biggest one day move in the bond since 1962! The dollar got smoked. Off 3-4% against the majors. The stock market caught a bid from the action in the bond market. All this happened in one hour and forty-five minutes.

Bernanke dropped a bunker bomb on the markets. Some were referring to it as a 'dirty bomb'. The bond market shorts got creamed. Bernanke announced today that he was going to buy $300 billion of Treasuries. In particular he said he would be buying the belly of the curve in the 2-10 year maturity. It was a shock to many. A game changing event.



One Greenwich based hedge fund reportedly made a killing. They got long the bond and short the dollar before the Fed announcement. Apparently they got the market insight from a report of a conversation between Bernanke and Volker. This conversation supposedly took place Tuesday night. The following is a transcript. It was found on the floor of a bar in Greenwich.

Big Paulie:
Ben how are you. I am just calling to say how good you looked on TV the other night. You're a celebrity!.

Gentle Ben:
Thank you. I thought I looked good with the make-up.

Big Paulie:
You did a great job. You probably bought us two maybe three months with that one appearance! So tell me, how did it go at the first day of the Fed meeting? Did you tell them what I said they had to do?

Gentle Ben:
Well, we discussed it and I must tell you that there is no consensus on this plan of yours.The Fed Board, led by me, has committed to a policy of quantitative easing. But the line in the sand on this policy is that we do not directly buy Treasuries. That would be monetizing the debt. When we make purchases of Agency paper we are achieving the benefits of quantitative easing but the Fed owns an actual asset in that case. This is a fine line. By crossing over and making actual purchases of Government bonds we will have set new and dangerous policy.

Big Paulie:
Ben, Ben, Ben. You have to be tough. You are not asking the Fed Governors for approval. You are telling them what has to happen. This is not negotiating time. This is decision time and this decision has been made. Finito!



Gentle Ben:
Well, I may be able get them to commit to buying some Treasuries. But only maturities of 1 year. And certainly not more than $100 billion. Anything more and it would kill the dollar. We do not want that. That will make it harder to sell the remaining bonds to the Chinese.

Big Paulie:
You are not listening Ben. Here is the deal. You are going to announce tomorrow that you will buy up to $300 billion of Treasuries in the 5-10 year range. We are going to kill the shorts. As for the dollar I want it 20% lower. I have a plan to fund the deficit. We do not need the Chinese.

Gentle Ben:
I do not understand. Who's underwear are we going to kill? I do not understand this short bond thing you speak of. Why would one want to be short? I am short and I can tell you it is no fun. You are tall, you do not know what it is like to be short.

Big Paulie:
Oh god. Forget that. Just focus on your side of the bargain. You get the ten year down to 2.5% and I will take care of everything else. Tell the other Fed governors that if they dissent on this I will take it personal. Very personal. They will understand. If you do this for me I will solve the problem of the deficit in return for you. Two devils bargaining.

Gentle Ben:
But how? How can you fund the deficit with a weak dollar policy?

Big Paulie:
You forget, I own the banks. They will do what I tell them to. They are going to fund the deficit for us. I am getting the reserve requirements cut to zero and the accountants will let the banks keep it all off balance sheet. Timmy G. and I cooked this one up. He is going to call the new bonds Perpetual Tees. The banks are going to buy a Trillion of this new crap. These bonds never have to be paid back. Neat trick Huh?

Gentle Ben:
Stuff the banks like the turkeys they are. That does sound good. Okay. I will do it. I will monetize the debt. I have sold my soul to the devil.



Big Paulie:
Good boy Ben. Okay I gotta go.

Click

FHFA's Lockhart to Congress – “We're Doing Great!”

FHFA Director James Lockhart issued a report to Congress today entitled, “Growing Number of Loan Modifications”. Director Lockhart touts the success of the Agencies:

“The report shows a 76 percent increase in loan modifications by Fannie Mae and Freddie Mac from the third to fourth quarters of 2008. There were 23,777 loan modifications during the fourth quarter, compared to 13,488 during the third quarter.”

Lockhart was even more upbeat when he reported:

“These more aggressive modifications should help lessen re-defaults and better stabilize the housing market and neighborhoods.”

I am sure that there are many Congressmen and women who will look at this report and get a warm feeling from it. A number of them will make reference to it when communicating to their constituents. “Here is evidence that Washington is working for the People. Come to my picnic and donate some money so that We can continue to do this good work”

Unfortunately nothing could be farther from the truth. Mr. Lockhart is misrepresenting the facts again.



In the footnotes on page two of Mr. Lockhart's report to Congress is the following:

“As of December 31, 2008, the report shows that of the Enterprises’ 30.7 million residential
mortgages loans 60+ days delinquent (including those in bankruptcy and foreclosure) rose from 2.21% as of September 30th to 3.02% as of December 31st.”

Mr. Lockhart 3% of your customers are in default. That means that you need to restructure the mortgages on 930,000 loans! You proudly point to the Agencies 'success' in restructuring 8,688 in the month of December. During that same month over 80,000 more of your borrowers went into default.

If you were fair and honest with the members of Congress and the American people you would have said:

“The Agencies were overwhelmed with loan defaults in the 4th Quarter. Loans 60 days past due rose by 250,000 to a total of 975,000. We were only able to restructure 24,000 loans, less than 10% of the number of new defaults. We do not have the resources available to address the problem. The capital required to restructure the existing book of bad loans would far exceed the total of $200 billion committed by Congress in support of the Agencies. On any reasonable accounting basis the Agencies have already stripped through that $200 billion. As of mid March 2009 we are faced with a total of 1,300,000 homeowners in default. Our phones are ringing off the hook. We are only capable of dealing with 10,000 restructurings a month. At that rate it will take us more than ten years just to deal with the current book of problems. Our inability to address the existing portfolio of bad loans is adding to the number of new defaults. The problem is now feeding on itself. Our customers are so fed up with our inability to even talk with them that they are just withholding their monthly payments. The private sector default rate is more than double the one we are reporting. The Agencies default rate will rise to the national average of 7% in the near future. As real estate prices continue to fall the default rate could rise to an average of 10% by the end of this year. This would imply outright losses in excess of $500 Billion.”

Mr. Lockhart, the American people need some honesty. You claim the problem is contained and you are dealing effectively with it. The American people know that is not the case. We just have to look at our own neighborhoods to see that the problems of housing are accelerating and your inability to cope with the problem is leading us to a point where broad based debt repudiation is increasingly likely.


The link to Mr. Lockhart's report to Congress:
http://www.fhfa.gov/webfiles/1656/FederalPropertyMgrreportMarch200931709.pdf

AIG Bonuses – It Gets Worse

The level of outrage in America today over AIG's $450 Million in bonus payments is palpable. You can't go to a cocktail party without someone bringing it up. This may be a water-shed issue for the Obama Administration. The line in the sand may just have been crossed. The rapidly growing realization is that the only way to stop this insanity is to stop the money from flowing. The anti-bailout movement has become a mainstream issue these days.


As insulting as the bonuses are, it just gets worse for AIG vs the Taxpayer. This from a Greensboro NC paper:

AIG United Guaranty posted an operating loss of $485 million in the fourth quarter of 2008. For all of 2008, losses at the Greensboro-based private mortgage insurer totaled $2.48 billion.

This division of AIG fleeced the taxpayers for $2.5 Billion last year. Five times the amount of those bonuses that the press is screaming about this evening. That this happened in 2008 is troubling. That it is continuing to happen in March of 2009 is just shameful. An explanation:

Fannie Mae and Freddie Mac have always had terms for a Conforming mortgage. A Conforming mortgage requires 20% equity from the buyer. There has always been an exception to this rule. If a Fannie/Freddie 'approved’ insurance company was willing to take a first loss (“PMI”) on the loan portion that was in excess of 80%, then the Agencies could still buy the mortgages. This simple abuse of good credit policy allowed millions of homes to be sold to borrowers who had no down payment and little chance at maintaining a monthly mortgage. At the heart of America's real estate collapse is the fact that those high prices could not be sustained without 100% financing being available.

Fannie Mae and Freddie Mac bought as much of this 'enhanced' paper that they could. The yields were great and how could they lose if the likes of AIG were going to guarantee the first loss? In 2006 FNM/FRE were trying to build market share in high risk mortgages. They kept the party going.

This has ended very badly. AIG's results are reported above. Fannie and Freddie have very big losses on their enhanced book of business as well. The losses on the enhanced mortgages far exceeded the portion that was insured. The only ones who have made out were the regional banks that originated and sold the risky loans to the Agencies.

FNM recently reported that its default rate on enhanced loans was 5 times larger than on loans that had the traditional 20% down. 22% of Fannie's 2008 business was enhanced. AIG was one of the biggest providers of the PMI coverage.

These questionable standards are business as usual today at Fannie and Freddie. They continue to buy pools of mortgages where the required equity of a borrower has been replaced with an insurance company guarantee. The incredible part is that one of those 'approved’ insurers continues to be AIG.

AIG continues to write first loss insurance on high risk mortgages. With this questionable promise to pay attached, the loans can be sold to another ward of the state, FNM. The taxpayer is being fleeced. Twice. And the numbers are very large.

The Swiss Dirty Float – Enlightened Self Interest?

G-7 currency intervention has not been implemented on a coordinated basis at any time over the past eighteen months. The carnage in the capital markets during this tumultuous period may have been averted or slowed if currency intervention had taken place. In an abundance of caution the G-7 Central Bankers chose not to act.

There are valid reasons why there was no coordinated intervention during this violent period of economic history. They include:

*Currency intervention is the last arrow in the quiver. It should not be used lightly.

*Currency intervention may have added to capital market volatility in the short term.

*Currency intervention can fail. When it does a period of even greater instability will follow.

Given the demonstrated reluctance of the global Central Banks to commit to a policy of intervention it is both surprising and shocking that the Swiss National Bank would embark on a currency war in March of 2009. What are they thinking?





Members of the SNB Governing Board

Jean-Pierre Roth, Chairman
Philipp Hildebrand, Vice-Chairman
Thomas Jordan, Member

Over many decades the Swiss National Bank was a source of stability in the currency exchanges. In past times of trouble their steady hand helped calm, rather than roil markets. The Swiss National Bank always had a 'seat at the table' when global Central Banks had hard choices to make. This history makes it even more surprising that the SNB would adopt a go it alone or beggar my neighbor policy.

There must have been some very strong motivation for the SNB to break with it's tradition. It is not clear what that motivation was based on a review of the data.

In the ten weeks thus far in 2009 the Euro/CHF rate has ranged from a high of 1.5200 to a low of 1.4700. This is not market volatility that justifies intervention. During that same period the CHF fell by 5% against the dollar. That Sterling is broadly weak is not an acceptable excuse for the SNB moves.

It should be no surprise to the SNB that the CHF is strong on a historical basis in the 1st quarter of 2009. Global financial developments are driving this. Over many years the Swiss have both benefited from and paid a price for their status as a Reserve Currency. From the period September 2001 through March of 2003 the Euro/CHF rate was below 1.4700. That period of overvaluation had its roots in 9/11. The SNB did not intervene then. Clearly the rules of this game have changed.

An argument has been put forward that the SNB has acted in response to the fact that the big Swiss banks have a mountain of CHF loans outstanding to Eastern European borrowers. Those borrowers earn salaries in Euros, or even worse, in local currencies that have lost much of their value. This factor was not mentioned by the SNB in their official communique. The SNB has an obligation to the banks. If concern for the assets of the banks was a motivating factor there were a variety of alternative options available to them. Currency manipulation is never justified.

The timing of the SNB moves is also confusing. The Swiss Finance Ministry is fighting a war on the front pages over banking secrecy. The US IRS has Swiss banking giant UBS in a vise. The currency moves by the SNB are unlikely to mend any of the many fences that have been torn up. It almost appears that the SNB is retaliating. It is also difficult for the SNB to cry poor on Thursday when on Wednesday ROCHE announces from Basel that it is finalizing its $47 billion deal for Genentech. Business can't be that bad.

In December SNB Chairman Jean-Pierre Roth announced that he would retire. No successor has been announced. It is rumored that Vice Chairman Phillipp Hildebrand is going to get appointed Chairman. It is surprising that such a significant step was taken by the SNB while the Chairman's position is open. It begs the question, “Who is calling the shots at the SNB?” Is it possible that Swiss Finance Minister and President Merz orchestrated the SNB actions? If that were to be the case then it would explain why the SNB chose to abrogate its international obligations in favor of purely domestic considerations.

It is unclear what the medium term consequences of the SNB moves will be. The darkest outcome would be that the actions taken by the SNB destabilize the Euro Zone further. If six months from now there is a 'two tier' Euro it will have happened in part because the SNB chose a dangerous course. One has to wonder if that potential outcome was considered by the SNB. If instability in Europe is a consequence then the Swiss economy will pay a high price. The end result of the instability will be that the CHF will be stronger than ever vs a basket of Switzerland's trading partners. The risks and rewards of the steps taken by the SNB do not seem to add up properly.

One outcome seems clearer. The position and image that the SNB has held in global financial matters for the past fifty years has been tarnished. It's likely that we will all pay a price for that.

ABC’s Betsy Stark – She Missed the Facts on GE

On Friday evening the 13th of March ABC News made a significant error in reporting the facts. Charlie Gibson asked Betsy Stark to explain the surge of the US stock market this week.

Ms. Stark responded, “Several large US corporations including GE were able to raise significant sums of money in the bond market without the assistance of the US Treasury or Federal Reserve.” Ms. Stark went on to comment, “These successful bond offerings were seen as evidence that the credit markets in the US were finally thawing, and that this is a key sign of a return to normalcy”.

Unfortunately nothing could be farther from the truth.

The Wall Street Journal has the story correct:

“GE said Wednesday the government will insure up to $139 billion of debt issued by its financing arm, GE Capital Corp., under a new program.”

If ABC does not like to read the Journal then it should have checked with GE on the facts.

“The conglomerate announced on its Web site that GE Capital has been approved to participate in the new Temporary Liquidity Guarantee Program operated by the Federal Deposit Insurance Corporation.”

The ‘Market’ may have been relieved that that GE got this credit support from the FDIC and was therefore able to borrow some much needed liquidity. It was just one week ago that the market was pricing GE’s credit default swaps at levels that indicated a possible default in the future. That risk has been deferred as a result of the FDIC guaranty program. However, as the months progress the reality that GE is unable to finance its operations without a guaranty will weigh on the company’s stock. Additional restrictions on dividends will be the cost of the government’s involvement. Restrictions on compensation similar to the banks will be the result. Surely some in Congress will ask for equity in the company as a price for the continued support. The resulting dilution will be yet another factor against the stock.

Ms. Stark is an excellent reporter. She should not have missed the importance of the FDIC’s role in GE’s ‘successful’ financing this week. The fact is that one of the largest and most important US Corporations is unable to finance itself currently without help from Big Brother. You must read this to mean that the lights are still dimming in our system, not that they are starting to get brighter.

Possibly a clarification is in order by the good folks at ABC.

Bernanke’s TALF - DOA

The Federal Reserve Board will launch the first phase of the Term Asset Backed Securities Loan Facility “TALF” program next week. The approved amount is a meager $200 Billion. The Obama administration has said it expects to expand the TALF to as much as $1 Trillion. These Trillion dollar numbers keep coming up and one would think that such enormous sums of money will surely lead to a reversal in the endless contraction of available credit. Unfortunately that is not likely.

The objective of TALF is to revive the moribund asset back security "ABS”market. Those that work in this space know that a shot in the arm of this once critically important segment of the credit market is necessary.

The ABS market is the off balance sheet side of the regulated financial institutions. The history books will point to the extraordinary growth of the ABS market over the twenty years prior to 2007 as the single biggest contributor to the financial meltdown of 2008. The Shadow Banking System that evolved had all the ingredients for a problem. It was unregulated. There was no recourse or accountability of the assets that were created by the regulated institutions. There was little or no equity in the vast majority of the deals that were securitized. Investment grade ratings were applied to the securities that had been issued. The rating agencies used seniority ranking to justify these ratings. The layer cake approach to the corporate balance sheet was embraced. With all those subordinated tranches ‘beneath’ the Senior paper those AAA rating seemed justified. As it turned out this was one of those assumptions that just proved to be totally false.

Timothy Geithner then head of the NY FED described the Shadow Banking System in 2007. He provided these insights:

$2.2 Trillion was funded by the commercial paper market.
$2.5 Trillion was funded overnight in the repo market.
$4.0 Trillion was funded short term by the large brokerage houses
$1.8 Trillion was funded short term by large hedge funds.

A total of $10.5 Trillion of medium to longer term assets were being funded by short term IOU’s before this credit bubble blew up. No wonder we are in trouble today.


Mr. Geithner commented on the shear size of the Shadow Banking System, “By comparison the traditional banking system as a whole held about $10 Trillion.” Possibly some bells should have gone off with this revelation.

There are very few players still standing that held this $10.5 Trillion two years ago. Those that are left do not want to be there any longer. Therefore in order to restore the true functioning of the ABS market something in excess of $5 Trillion has to be poured into it. The $200 Billion of TALF money that has been committed represents 2% of the outstanding ABS market. If the Obama Administration can sell Congress on an expansion of the program they might get the funds to extended the TALF to a total of $1 Trillion. That will still be less than 10% of the level outstanding at the end of 2007. The proverbial drop in the bucket.

As of this writing it has not yet been established whether the TALF program will accept only “new’ financial assets or permit banks to re-securitize their old book of IOU’s. The banks want the opportunity to rearrange the deck chairs on their Titanic. The FED/Treasury are trying to create a ‘home’ for newly created assets. The most likely result will be a clarifying announcement next week that permits both old and new assets to be eligible collateral for TALF participation.

The FED will require that the collateral provided to TALF have a long-term credit rating in the highest investment-grade rating category. They require that these ratings be from “two or more major nationally recognized rating organizations”. In other words the FED will be relying on S&P, Moody’s and Fitch to determine what is “acceptable”. Talk about repeating the mistakes of the past.

The definition of Eligible Collateral for participation by a bank at the Discount Window of the FED today is much broader than the definition for eligibility under TALF. Therefore any bank can finance all of the collateral they have available without need of the TALF. The banks want TALF because it gets the assets off of their balance sheet and into the unregulated Shadow Banking System. This is old school thinking. Balance sheet size and earnings per share were the metrics that drove the creation of the ABS market. EPS is a dead concept for banks in 2009.

At an initial size of only $200 Billion TALF is irrelevant. That it will be increased to near $1 Trillion seems inevitable. President Obama, his economic team and Mr. Bernanke have all spoken volumes in recent months on the need for greater regulation and control of the credit formation process in America. It is interesting to note that the TALF program will provide a Trillion Dollar package in support of the unregulated Shadow Banking System.

Surely Mr. Bernanke, Mr. Geithner and President Obama are aware of this glaringly inconsistent policy. What concerns this writer is that in the rush to “do something” the Administration and the FED has overlooked this conflict and will stumble on it in the coming months. Either way TALF is DOA.

UBS vs USA – It’s Getting Worse

This may be a high stakes week in the drama of UBS vs. the US IRS. There is talk this weekend that the Justice Department is soon to make arrests, arraignments and ‘perp walks’. If that is to be the case you must read this as just another visible effort by DOJ to shake USB’s tree. If this does take place this week it confirms that DOJ is moving ahead without consideration to the fact that the global financial system is currently very vulnerable.

Making matters worse are some recent comments from a number of Wharton School's professors.

"Swiss banking as we have known it is dead," says Wharton professor of operations and information management Maurice Schweitzer.

That is pretty strong language from Professor Schweitzer. Even more troubling:

Philip M. Nichols, Wharton professor of legal studies and business ethics acknowledges that the lack of transparency and accountability invites abuse. "When I talk with people involved in corruption all around the world, the phrase 'Swiss bank account' almost always comes up."

This is not so good news for Swiss Finance Minster Merz. Possibly he is attempting to strangle Professor Nichols in this picture.


I am not sure why the Wharton School has UBS in it’s sights but it just gets better and better, or possible it just gets worse and worse:

"UBS management was really tone-deaf in terms of U.S. tax policy," says Wharton finance professor Richard Marston. "The one thing that distinguishes investors in the U.S. from many European countries is the concern that they don't violate tax laws. It's taken seriously by the IRS, and everyone clearly knows this."

If professor Marston is suggesting that other countries whose citizens have black accounts in Switzerland do not care about lost tax revenue, he is just dead wrong. The European press is reporting on efforts to pursue their country's tax cheats on a regular basis. You can be sure the tax authorities in the UK, France and Germany are just letting the US IRS do their work for them. When the US side of this is resolved the rest of the world will line up for the names of their citizens. In a year where tax revenues are light this seems like an obvious place to go for $30-40 billion.

Professor Nichols went on to comment, "There are still plenty of countries in the world that are somewhat authoritarian, in which the government basically takes money from the rich and keeps it to themselves. To wealthy persons, [secret accounts] are an invaluable tool for legitimate purposes." But for those government or NGO (non-governmental organization) officials who are trying to aggregate and mobilize capital for development purposes in emerging economies, "they are somewhat frustrating because we wish the capital would stay in the home country."

This type of thinking is going to keep the pressure on the Swiss banking industry for a very long time. This is the Wharton School that is doing this talking, after all.

Possibly the most troubling comments are from Wharton finance professor Marshall Blume who said, "Certainly people who have ill-gotten gains find it attractive to hide them there. For the U.S., it's tax evasion, but for other countries it's more a place to hide money."

This comment is the crux of the matter and the issue that is most daunting to the Swiss Private Banking Industry. The words, ‘ill gotten gains’ or ‘forbidden fruit’ are coming into this debate at an ever-increasing rate. If this coming week’s Perp Walk of the first 250 names results in an accusation that some of the money that is in these accounts is in fact, “tainted” that will change the entire direction and out come of this story.

The IRS and the Justice Department are doing their best to bust up UBS. As of today the American people could care less. Secretly a lot of them are wishing they too had an account that hid income from the taxman. However if the debate is shifted to ‘hiding ill gotten gains’ versus, ‘I cheated on my taxes’ the sentiment in the press and in the public will turn against the Swiss very quickly.

If those perp walks do happen this week it is going to be very tough on all of those folks working on the Bahnhofstrasse. This is especially true for UBS’s new Chairman Kaspar Villiger and CEO Oswald Grubel.

Secret conversation between Volker and Geithner.

Transcript of phone conversation between Paul Volker (“BIG PAULIE’) and Tim Geithner (“TIMMY”) March 4, 2009. 8:20 PM EST.

BIG PAULIE: Good evening Tim. How you doing Kiddo? You still in the office?

TIMMY: Hi Paul. Thanks for calling. I guess I am okay. It was another bad day for me.

BIG PAULIE: Those Senators tough on you? I could not tell. CNBC had you on in a small box in the corner with no sound.

TIMMY: Yes it was tough. Not as bad as the House though. They all want to blame someone and I am always in the way. I am at my desk now, looking at the email and phone messages. 90% are negative. The press, half of Washington, foreign finance officials, industry leaders. Irate voters from every State. They all hate me. They blame me because I am the one in the hot seat.

BIG PAULIE: That bad huh?

TIMMY: You should see the Blogs. It breaks my heart. Half of them refer to me as a tax cheat.

BIG PAULIE: You are a tax cheat.

TIMMY: That was a computational problem. 80% of all Americans have had this problem at one time or another. I did get one nice note from Jeff Immelt. He wrote of kum by ya. What does that mean?

BIG PAULIE: Oh boy…. Speaking of GE I got a call from Jack Welch. He said he would become a Democrat if the President spoke nice about GE. Heh.heh.heh. (the noise of the lighting of a cigar is heard)

TIMMY: Well, I am so sorry that I have failed the Administration in these critical times.

BIG PAULIE: What fail? You are doing a great job. Perfect in fact.

TIMMY: I don’t get it. How is that possible given the negative reviews my financial plans have received? The markets are collapsing!

BIG PAULIE: We set it up for you to fail Tim. Sorry. We needed a beard. We needed to have someone propose the conventional approaches to economic problems as a blue print for addressing today’s black hole. We knew you could not sell that sack of weeds. Before we came forward with Plan B we had to let you and the “conventional wisdom” have a shot. (Puff, Puff, Puff) And then let you fail.

TIMMY: You set me up? Who is we? What the hell is plan B and how come I do not know about it? What does a beard have to do with it?

BIG PAULIE: Slowdown. Here is the deal. (Puff, Puff) There are going to be some changes announced. I am going to become actively involved in the big issues we are facing. You are going to continue to be Treasury Secretary. I will assume the title of Uber Secretary of Treasury.

TIMMY: Uber? Does this mean I lose my office?

BIG PAULIE: You can keep the office and get to go to all the meetings. But, you report to me. Get it? You can call me Boss.

TIMMY: Well, I guess that is a relief. So, Boss What is plan B?

BIG PAULIE: I am calling it the Low/Short, High/Long - Gap Fund Program.

TIMMY: What? I did not understand a word you said. Let me get some paper. You talk too fast. Hold on….. Okay, now I have a pencil. What did you say about gaps?

BIG PAULIE: Plan B is the VolkerII Plan. I call it PLOVER. It will bring Shock and Awe to the global financial markets. In less than one week I will solve the $2T funding gap and also solve the balance sheet problems of the top fifteen banks in the Country.

TIMMY: Hold on. I am writing this down. Shock and awe… All the funding… Fix the banks... One week... Hmm. I can’t wait. How are you going to do this?

BIG PAULIE: Treasury will create a new evergreen security. It has no stated maturity. It is a floater. It is re-set based on the future t-bill rate. It will be priced at 35 BP over Treasuries. We will sell two Trillion of this in one week.

TIMMY: No way Jose!. We are having troubling lining up buyers for 50-60 billion. Forget 2 Trillion. In a week no less! Even you can’t do that. No one can sell that many bonds. If you price something like that at 35 beeps no one will come to your party!

BIG PAULIE: Let’s just say I know the buyers.

TIMMY: Huh?

BIG PAULIE: The fifteen banks are going to buy it. All of it. In exchange for the American people extending a hand and setting them right the banks return the favor and buy the bonds. Get it? I am going to stuff the banks with this. Remember, we own the banks. They will do anything I tell them to. You think EPS means anything anymore? I will call these new notes Federal Agency Resolution Trust Securities. This is the Low/Short side of PLOVER. Low interest rates for Short-term borrowing.

TIMMY: Okay. I am writing. Let’s see. Stuff the banks…. No EPS….We own them….Low interest. That does seem easy! Now the name. F as in Federal… A as in Agency…. R as in Resolution… Oh! I see a problem! With the name I mean. How about this? We can call them Perpetual Tees. People will think of underwear that lasts for decades! See! I am contributing to the process! But how do you fix the banks? Surely the banks can’t buy these Notes unless they are made sound. That is the core problem!

BIG PAULIE: In the same week Treasury will issue $2 trillion of 20-year zero-coupon bonds. The yield on the bonds will be set at 10% The cash price for the zero’s will be 15% of par with the big implied coupon. The fifteen banks I choose will get the right to buy these beauties. They will use the Zero’s to immunize themselves against principal loss on $2 trillion of dodgy paper they have on their books. We will capitalize the lucky fifteen with the remaining TARP money. They will use that new capital to buy the zeros. 300B in 300B out. We round trip the money. Therefore there is no money. I already have the accountants in my pocket on this. That was a lay up.

The banks will agree to use this accounting break to restructure all manner of loans providing real debt relief. With the zero’s behind them they can no longer take a loss and therefore any settlement is bottom line income.This is the Long term/High rate part of PLOVER.

That is it. We start on Monday. We finish on Friday with the securitization of $2T in stinky paper backed by the zeros, the banks are saved, the deficit is pre-funded for the next 18 months, Treasury has raised $2.3 T in cash with a decent duration and a reasonable average blended cost. Saturday I go to Canada to fish for Salmon. (Puff, Puff, Puff)

TIMMY: This seems so simple. Why didn't I think of it? One thing I see is that your plan is at risk to rising short-term rates. What is your response to that?

BIG PAULIE: That is the gap funding part of PLOVER. Get your seat belt on Timmy. We are making a big rate bet. Let’s say I have an understanding with Bernanke. PLOVER keeps the assets off of the FED’s balance sheet. In exchange Ben will set rates where I need them. It’s all a deal Timmy. I gotta go.

TIMMY: Good night Boss.

CLICK.

Heard from TIMMY: I think he just took over Treasury. Gulp

Heard from BIG PAULIE: I just took over Treasury. Puff, Puff, Puff

The Case Against Gold

If you lucky enough to have a few bucks left in your pocket to invest these days you are faced with the dilemma of what to do with it.

No question but that stocks are cheap. But the chances are you already own stocks and you have lost 50% in the past year so why would you want to add to that category? For those out there that are waiting for that Vee shaped stock market recovery, forget it. That is the least likely scenario out there. We are not getting out of this mess anytime soon. Pick any stock that you like. Regardless of how cheap it is today you can still lose half of your money in a fortnight.

Bonds are the other traditional alternative. They are problematic too. Either you get a high-grade bond like Treasuries that pay you nothing or you can invest in any of the busted corporate bonds that are already trading at big discounts. It is not hard to find decent corporate bonds around these days that pay you a yield north of 6%. So what? Most corporate bonds are going to be downgraded in the coming years. Do you really believe that GE can keep that AAA? Not a chance. Keep in mind that the vast majority of corporate bonds are never paid off. They are just re-financed. In today’s market even the likes of GE can’t go to the capital markets without the benefit of an FDIC guarantee to get the bonds out the door. As it looks now a lot of those corporate bonds that look so nice today are going to pay you off with more paper, not cash. The “best case” is for a recovery in the global economy. While that does not look likely ,if it should happen it would result in a rapid increase in interest rates and there goes your bond portfolio.

Real Estate is another big investment category that looks like an area to avoid. I think that REITs in general are just a huge black hole waiting to suck you up. Walk around the main streets and malls of your area. The stores are closing folks. In a year we will have lost an incredible amount of commercial real estate tenants. If you think there is safety in commercial REITs you are just going to be disappointed.

What is “safe” has a negative carry to inflation so you lose. What is worth looking at is fraught with risk. If anything that is backed by “paper” is suspect, then surely Gold has to look good.

The market seems to believe this. We briefly broke through $1,000 last week. The TV talking heads that are not allowed to speak on camera without a “BUY” recommendation on something have been touting the yellow metal non-stop.

I do not make market calls. There are too many surprises out there on a daily basis to stick one’s neck out. If gold were to be either $700 or $1,200 in two months I would not be surprised. The only market bet that I am prepared to make is that substantial volatility in all asset classes will be the norm in coming months. Clearly an opportunity to make money. Just as clearly an opportunity to lose some more.

With all of this chaos it is not surprising that Gold catches a bid. It has always been a go to asset class in times of trouble and we have some trouble.

One of the big arguments for gold is that all of the money that all of the Central Banks are printing these days will come back to haunt us at some time in the future and inflation is going to come roaring back on a global basis and gold is going to soar when that happens.

That will almost certainly happen. I wish today that the near term forecast had a risk of inflation attached to it. Bunk. Take a look at all of the other asset classes that are a store of wealth. They are tanking. On that basis gold may retain its value better than stocks, bonds and RE but that just means you will lose less. All investments are “Timing Trades”. In 2009 timing is everything. We are facing massive deflation today. On a global basis the Private Sector has reduced consumption by an astronomical 10% on an annual basis in just the past few months. Inflation will be the end result of the problems of today. But first we must ride ourselves through several more years of deflation before inflation becomes the “big risk”.

Historically gold has been a place to hide when the dollar is weak. If the dollar falls by 10% against the Euro gold has to move up vs. the dollar . That is just the way that the capital markets have moved. That is not the case in 2009. The Euro/$ is reflecting the problems in Europe and all those troubled countries east of Germany. For the foreseeable future these fundamentals will not go away. Therefore gold is currently running against its historical trend. Always a red flag.

A long time ago I was a young buck trading commodities. It was a time like last spring when commodities were hot and money was flowing to them. Copper was my commodity then. The price was pushing $3 per pound and I was super bullish. I guy who had been watching the tapes for a long time stopped by my desk and dropped off a roll of pennies. He said, “It can’t go higher. They will just melt the pennies”. Way back then pennies were made out of copper versus the zinc of today.

Of course he was right. In the months and years that followed copper slipped back to that comfortable $1-2 range that it is stuck in today.

There is a well-quoted fact. 98% of all the gold ever mined is still out there. In the next few years things are gong to get very tough for all manner of consumers. When there is no food in the cupboard, when there is no money to pay for heath insurance or Dr. bills gold will be liquidated. When we have sucked through our cash savings we are going to liquidate what is left to keep things going. That means that people will sell their gold. When you can sell that old wedding ring for $400 and you are hungry it is not much of a choice.

Watch the business channels in the US. There are non-stop commercials, “Sell Your Gold Now”. An industry has emerged where small gold holders can mail in their jewelry, have it melted and get a check in the post. This trend has not had a meaningful impact on global supply/demand conditions yet. But, as the economies around the globe slow further, as consumers and Governments run though their liquid reserves they will sell what is still liquid and has some value.

Gold is off nearly 10% since that 1,000 print. It was fear and front running that got it to that price. There was no real demand. If you feel today that you are long and wrong take heart. The ‘fear’ thing is not going away anytime soon.

To be a bull in anything today you have to be able to make a case for a ‘double’ in the next twelve months. This means gold at 2,000. Gold bugs, there are an awful lot of things that are more likely to double from today’s levels in the next year than gold. Let’s face it. If the S&P is at 500 in a year , gold is a short too.

There is no “safe” place to hide.