Back to Ike. The joke's on us.

After making a few jokes the President went on to defend his budget at his talk today. He said that if his budget were enacted it would result in the US achieving the lowest debt to GDP ratio since Eisenhower. That’s quite a claim. I don’t think there is any truth to it. I don’t believe Obama really believes that is the case either. He's just blowing political smoke.

The budget that “produces” these great results is actually built on sand. The assumptions that result in the dramatic improvement the President is counting on are not going to happen. Therefore we are in for a disappointment.

The CBO produced a set of slides last week that describe the economic fundamentals that are behind the magic the President is selling:

The key assumption is that GDP is onward and upward every year for the next ten. Forget the structural weakness(s) that makes this most unlikely. Forget that the US has a recession of some form or another every five years or so. If this completely Goldilocks outcome is the future then the Prez is right. We have nothing to worry about. The problem is that this scenario is the least likely outcome.

This graph stinks to me. Somewhere around tomorrow (or the next day) unemployment is going to plunge according to this. It will fall in just a year or two from now to a level not seen in history. And it will stay at that “perfect” level for, well, for ever. Give me a break!

This shows the rate of jobs creation. A hockey stick is what it is called in finance. And financial guys know whenever someone shows them a plan like this, you just look the other way on the deal being offered. Hockey sticks never come true. Those that bank that they will, are always the losers. In this case that means the public.

Sub 2% inflation. Forever. The lowest rate on the charts. No wonder the president’s budget looks so “good”. His core assumption is that the rising cost of government will be tame. If you build a house on this assumption, your house will fall down.

These final charts look at that phony “Baseline”. Even the CBO admits that in order to achieve that baseline some big changes must be made. If we don’t, we end up on that lighter blue line. So what are these pesky things that are referred to as “certain policies”? The answer is: (I) All of the Bush tax cuts get reversed. (II) AMT is indexed (major tax increase on all income over $75,000). (III) Deductibility for all types of things (mortgage interest, property tax, state income tax) is eliminated.

These things will not happen. If they did we would have the longest running recession in history as a result. The budget deficit would be north of 10% forever if we did that. And the CBO, OMB and the President all know that.

No wonder the big O was cracking jokes. It’s a good strategy. It gets the audience distracted from the facts.

CBO on Migrant Workers

I came across this slide from the Census Bureau.

When you do the calculations on births/deaths/migrant workers you get the following results:

Annual births: 4.5mm

Annual deaths:2.9mm

Net change: 1.6mm

Net new migrant workers 790,000

From this one gets the total increase in population at ~2.6mm. Fully one-third of that growth comes from foreign immigrant workers. I was surprised to see how big the migrant worker side of the equation was. That comes to 66,000 a month. If you follow the monthly Non-Farms Payroll report you know that there have been many months that we don’t create that many net new jobs.

Our friends at the Congressional Budget Office just happened to have issued a report on this subject on Friday. Catchy title:

A slide that I thought was interesting shows just how much money is leaving the country from those foreign migrant workers:

The total came to $66 billion in 2009. That is a very big number. Of the $31b that left the shores to go south of the border $20b ended up in Mexico. Asia was the beneficiary of $17b of inward money flows. Of that, $3.2b went to China. China manages to suck the blood out of the USA every which way. We send them our money for interest on our debt. We send them money for everything we buy from them. And those who come to work here send back a few billion more.

Allow me to “play” with these numbers a bit. I believe that the vast majority of the money going to Latin America (31b) is from undocumented workers. The same is true for the $5b going to Africa. I will assume a conservative estimate that only 50% of the $17b going to Asia is from illegal workers (9b). I will be generous and exclude all of the money (total 15b) going to Canada, Europe and the Middle East (there are many undocumented workers in this set). My conservative estimate is that ~$45b a year is leaving the country from undocumented workers.

A question is, “How much of an illegal workers pay is being sent back home?” My answer to that is: “Somewhere between 0 and 50%". Call it 25%. This means that a worker sends home one week of wages for every month that they are here. I actually think the percent number is lower. It is hard to get by in America with just three weeks of wages a month. The savings rate for Americans is less than 5%.

If you accept my (conservative) one week in four argument then you can conclude that the total wages being paid to these workers is ~$180b a year (4 x 45b). That is a very substantial amount of money.

The average legal worker pays 7% in Social Security and other FICA taxes. The average Federal tax rate is about 20% and the average state income tax is another 5%. It comes to about 33 cents on the dollar.

Put that together and you get lost tax revenue of ~$60b (180*.33). I think this is a pretty good estimate given that I excluded the $15b going to Europe/Canada and 50% of Asia. But I will ‘haircut’ this estimate down to $50b a year. That still is a hell of lot of money.

-A ½ Trillion over the next decade would be very welcome.

-$50b a year would solve all of the state’s problems if the money were committed to them over a long period of time.

-$50b a year would be a hell of a down payment on the energy infrastructure build out that we so desperately need.

-$50b a year would turn Social Security into a perpetual “pay as you go system”. We could forget about any funding shorts falls forever.

-$50b a year would go a very long way to bring our educational system back up to par.

What would you do with an extra $50b a year? Let’s face it, we need this money and it would be very helpful if we had it.


The bottom line is that America needs immigrant workers. We also need the tax dollars that come from the wages that are paid. We don’t need to have all this money just leak out of they system while the social costs of illegal workers stay in country.


This is America’s Black Economy. It stares us in the face every day. For the life of me I can’t figure why we don’t confront the problem. But notice that neither the Republican nor the Democrats have even raised it as an issue for 2011. They are too busy fighting over budget cuts, yet there is a big bucket of money right at their feet.

We don’t need to solve the broad immigration problem today. That is a very complex/emotive task. We should start the process by making sure that illegal workers pay their taxes. Just like the natural American workers do.

FASB’s Karma

In my view the Financial Accounting Standards Board is doing the country a great disservice. A few years ago when the feces was hitting the fan on a near daily basis it became abundantly clear that accounting standards had to be changed.

Two areas that were abused big time and contributed to the problems were the issues of mark to market and lease accounting. These categories are where big leasing companies can hide debt and manipulate earnings. Financial firms can hide book losses under the guise that they will “Hold to Maturity”. Insurance companies can write derivate contracts that are “off the books”.

There were firm promises made that things would change. Unfortunately FASB has folded like a cheap suit in the rain. There will be no better disclosure in the future than in the past. Therefore the past will be repeated in the future. The scary thing is that FASB is a financial slave to those who benefit. Same old, same old.

I keep hoping that there is a Yin and Yang in the world. Some hidden force that attempts to bring balance. Who knows? In the case of FASB they might have just gotten hit on the head with some Yang. Consider this lawsuit:

This is a patent/licensing suit. I don’t know the merits. Just the suggestion that FASB was playing fast and lose makes me grin. The case has made it to Federal Court. So there will be a ruling. I’m hoping FASB loses big time. They have that “Bad Karma” thing hanging over their head.

SS Newbies - 60K a Week!

I follow what’s being discussed about Social Security. A Google alert produces 20 stories a day on average. In my view most of it is drivel. The passionate (and prolific) supporters of Roosevelt’s great legacy constantly make the same assertions. That SS has a Trust Fund that will last until 2037, and that SS does not have any impact on the deficit. Neither of these things are true.

When you look at a financial statement always look first to the lower right for the “bottom line”. It's no different with SS. Their bottom line for 2010 was a deficit of $49b.

This is how the Trust Fund presents its results. They don’t hide the deficit. They highlight it, as they should. I just wish that Huff Post and all the others that are blathering that "SS is off limits in 11’ as there is no problem” would just shut up and read what SSA is reporting.

I try to forecast these numbers. My estimate last summer was -35b. So I was off by $14b. I thought I had a negative view. I still missed the revenue number by 3%. A year ago a fellow who knows SS quite well suggested that I was “Chicken Little” with my forecast that SS would begin a period of perpetual deficits in10’. After all, this was not supposed to happen until 2016.  But, of course, it has happened.


In 2010 there were 1,509,278 net new beneficiaries of SS checks. Ten years ago in 2000 the number was 462,740. The rate of increase is more than three times what it was just a decade ago. There are a bunch of folks who are, let’s say, leaving the system. Therefore the actual number of newbies getting checks is closer to 2.5mm a year. It comes to 60,000 a week. Business must be booming at SSA. Clearly this is a “growth” story. If you’re looking for work, file an application with the local SS office. They’re hiring. AdMin at SS was $6.5b last year. Look for that to go up by at least $500mm in 10’.

My current outlook for SS in 2011 is a picture not unlike that of 10’. I see some evidence that the revenue side (payroll tax) has stabilized. On the assumption that we see full year GDP growth around the current thinking of +3% I would expect revenue to grow by about $25b. I am much more confident on my outlook for expenses. These will come in at least 25b higher than 10’. Absent any significant prior year adjustments this would put the full year cash flow in deficit by $40-60 billion. The critical ratio of Pay Roll tax minus Benefits will be in deficit by $55-75 billion. Call it a disaster. And that's the "good"news.


Note:
I’m laughing at myself while writing this. My forecasts are based on a 3% growth story. But look at the headlines. The global energy complex is in doubt at the moment. Sure, a case can be made that the new “Ins” that are coming to govern these critical areas will be motivated the same as the old “Outs”. Money. If they don’t pump, they don’t get paid. I don’t care who is in. They all will need money, so the best chance is a soft landing. A speed bump, at worst. But if you had asked me a month ago to make odds on what has happened I would have lost a ton of money. The situation and any economic projections are simply up in the air. I am reminded of this version of an old story:

A scorpion and a crocodile meet on the banks of the Nile. The Scorpion says:

“Crocodile, please let me crawl on your back and swim me across the river. I need to get to the other side.” The crocodile responds:

“Not a chance! If I let you crawl on my back you would bite me and I would die!” The scorpion answers:

I would never do that. If I bit you while on the river I would drown. Rest easy and give me a ride.

The crocodile thinks this over, sees the logic and agrees to give the scorpion a lift. But in the middle of the river the scorpion bites the croc and they both die. Before he goes under the croc yells to the Scorpion. “But why? Now we are both doomed.”

The scorpion cries out, “Nothing makes sense in the Middle East!” 

(yes it's real. LINK)

Onondaga

I’m not a muni analyst. I just look at numbers and make observations. I took a look at Onondaga County, NY. The home of Syracuse.

The county has a Aa1/AAA rating from Moody’s/Fitch. I have no idea what a AAA means today. The “top shelf” should be something that is more certain than the economic winds of up-state NY in my mind. That said, my look at Onondaga says they are a good credit. The outstanding bonds are money good. If you own them, sleep tight. They will pay interest and principal on time. If that’s the definition of a AAA, they meet it. O does a very good job of presenting its numbers. There were a few things that I thought were worth noting. I use some of the information in the broader context of the muni market:

According to the census there are 455,000 residents . 14% of the population is over 65; 23% are under 18. 74,700 have disabilities. The healthy adult workforce is about 270,000. I’d be surprise if 70% had full time jobs.

Syracuse University has a total of 31,000 students. The faculty is 1,500. The budget for SU is $1 billion. A decent chunk of that stays in O.


-The Onondaga 2010 budget:

A net deficit of only $2mm. Not bad on a $1b expense base. But look at the sources of revenue. The State kicks in $119mm (12%) and the Feds $88mm (9%). The state of NY has its own problems. Not just this year. It will be every year for the next ten. Along the way Onondaga is going to get squeezed. The Federal side is no different. Those numbers are going down. They will go down for nearly every county in the country.


To make a point, the following is a listing of outstanding muni bonds:

My impression is that this is a fairly complex financial position for a community of 455k people. O pays $45,000 a year to agents just to distribute the interest. Think of the legal fees for all those bond indentures. The underwriting spreads for Wall Street are a daily source of revenue for the folks with white spats. Secondary market trading of this paper is a flow traders dream; you can drive a truck through the bid offer spreads. No wonder everyone loves it. With this much debt everyone makes money. Right?

It’s important to note that there is gross and net bond debt outstanding. O has defeased some older high coupon bonds. In my view they have done a very good job of taking advantage of both lower interest rates and their strong credit rating. They “arbed” Ben Bernanke with his QE and ZIRP. Along the way bondholders (aka Savers) get less for their money. So O wins, savers lose and Ben is the broker for this.

The current principal outstanding is 441mm, but $244mm has been pre-refunded. So net debt is only $197mm.

When you look at O you have to focus on the net number. But I am troubled by this phenomenon. What you see with O you will see with almost all munis. They have much more debt outstanding than the net debt they are rated on. Yes it is true that the PreRe stuff is now secured with solid assets (government guaranteed bonds. They are called SLUGS (State and local Gteed. Securities)).  But heaven forbid there was a call on the SLUGS during a government shut down. Something like that could never happen, could it?

This feels a bit like ponzi land to me. There is much more muni debt outstanding than there is debt reported on the balance sheets of munis. The problem becomes if/when this paper starts rumbling around. (like it did with Agency bonds).

As of 1/31 the Treasury SLUG account had $187b of paper out. Is this 187b of extra funding for Treasury a big deal? No, not really. What’s another $200b amongst friends? It is only 13% of the 11’ deficit. Well, actually, that is a fairly big deal.

 

So why does O deserve a AAA? Easy answer: They have a solid tax base. That income stream is (technically) committed to the bondholders. Some values/tax numbers:

Note that the tax revenue declined YoY by 16%. They lowered the mil rates. They could have kept the mil rates the same and lowered the assessed values. The result would have been the same. I don’t believe the value of real estate in Syracuse has appreciated over the last four years. I suspect it has gone down quite a bit. The value of the RE is not the issue. It is the property tax that is generated that counts. The 2011 revenue is lower than it was in 2003. Given that the assessed values seem too high, further drops in property tax revenue is likely.

The revenue from this property is $154mm in 2011. That comes to 78% of Net Debt. A favorable ratio. More importantly is the revenue to current year debt service ratio. Principal ($15mm) and Interest ($9mm) for 2011 is $24mm. O covers their debt nut 6Xs. That justifies my view they are ‘money good’. It is the basis for that lofty AAA.

Based on the property values being assessed a formula is used to establish the maximum amount of debt that O can have:

NY State law sets the formula for the maximum debt level a community can have. (7% of the average of the “Full Value” of the property base) From this comes the conclusion that O can have up to $1.4b of debt. Given that they are well below that level ($200mm/12%) they are considered a AAA. Just the idea that O has nearly unlimited capacity to borrow money bothers me. (another 1.2b or 6X increase)

This a flawed concept. I can accept that the lower this ratio is the better the credit of the borrower. But what is the value of that real estate? What counts (to me) is the taxes that come from the property. Setting a debt limit based on inflated property values is not a concern with O. But other communities are kidding their bondholders on what this key ratio is.

The business of defeasance I previously touched on has created significant benefits for O over the past decade. I think the window for defeasance has closed. As the cost of new debt rises the opportunity to ReFi goes away. Consider this BABs bond O issued last year. A 5 1/8% coupon bond is now yielding 5.80% (trading at 93). This is a proxy for what it would cost O to issue new debt. The ReFi window is closed for O, (and most other munis across the country). This increase in borrowing costs is not a reflection of O; the entire muni yield curve has gone up. The ten year is has moved a very significant 75BPs

The following is a discussion of the historical savings from defeasance activity:

Taking advantage of the lowest interest-rate environment in forty years(thanks to Ben B) , the County refunded $18.5 million of 10-year old bonds in 2003, saving $1.8 million through 2014. In 2005, the County participated in a second pooled tobacco bond sale, which enabled the County to defease $19.9 million, beneficially affecting the years 2007 - 2025 for total debt service relief of $27.3 million. In late 2009, the County issued $33.3 million of refunding bonds, enabling savings of $3.3 million in 2010 – 2023.

It is the County’s goal to annually review its outstanding debt for refunding opportunities. In 2010, The County maximized its interest savings by issuing a mix of tax-exempt, Build America and Recovery Zone bonds.(Sorry O, this benefit has left the barn, and it's not coming back.)

Syracuse University is a power force in the local economy. I have no doubt that this fine school will be contributing to economic activity (and taxes) for a long time to come. But, once again, I see chinks in this armor. The tuition at SU this year is $50,791, up 6.2% YoY. This is a big nut. In years past tuition cost was supported by Pell grants, donations, investment returns from endowments. The money also came from tapping 401Ks or a ReFi of the family home. A ton of it came from student loans. Most of that has gone away. I wonder if SU will be the driver of growth that it has been in the past.


O has a large capital budget. They need to make repairs to old “stuff’ and build new “stuff”. It’s a long list. A significant portion of this has to be financed with new debt.

The capital plan:

Source of funds for capital spending:

Note that only 12% of the budget comes from reserves. The balance is either borrowed or is grant money from the State or Feds. This is the model that has been in place for years. I don’t think that model is going to work so well for the next decade.

Conclusion

I don’t see a credit problem with O in the foreseeable future. I would put the odds of a default or a restructuring around “0”. But I see signs of weakness. Both in the micro-economics of O and the broader macro dynamics of the muni market.

For what it is worth I have trouble accepting the Aa1/AAA rating, NY State GO bonds are rated Aa2/AA. What happens in Albany will flow down to O. Wanna bet on at NYS downgrade in the next year?

If you don’t own O’s bonds yet and are looking for a chance to buy in, I would hold off. Yes, the bonds have gotten cheap of late. I think they will be cheaper still in the next few years.

Shipping News – Floating Storage/Tanker Rates & Pirate Update

For years there has been a large supply of crude floating on big oil tankers. A significant portion of this is not under contract and does not have a specific delivery date. Typically these vessels head for Asia or the Americas. They do it at slow speed. They wait for contact from the owners that the crude has been sold and a delivery date has been set. When that happens the ship picks up speed and heads to the intended port.

It is my understanding from talking to some shippers that this is happening in a very big way as I write. It makes perfect sense. If you were China Inc. and worried this morning about the predictability of supply, the first thing you would do would be to secure as much of the floating crude that was out there. We saw this same pattern in the early days of Egypt. Back then the rush was to bulk up on supplies of wheat. Today it is crude.

Two consequences from this. First a minor one. The cost of chartering an oil tanker has falling from a high of $200,000 per day to as low at $20,000 of late. We are going straight up on this number. Transportation is part of the cost we pay to import the 10mm barrels of oil a day we consume. This increased cost will flow very quickly into the cost of gas.

More importantly is that the cost of spot crude (not futures) is going to skyrocket. It already has. Look at the price being paid for spot crude at the Gulf of Mexico. It opened this morning at $112. There is a $20 premium for physical crude versus WTI Should the current uncertainties on supply continue (or worsen) $4 gas in the next few months is a foregone conclusion.

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PIRATE ACTION

So the Somali pirates killed the four Americans on the sailing ship. This appears to have been prompted as a result of some effort by US forces to liberate the ship before it made land. As of now the report is that all of the pirates were captured or killed.

This is a terrible result. I wrote about this on February 11th. I concluded that report with the following:

Military action is not far off.

The apparent failure of US Special Ops to save the Americans confirms my prior observation. The only solution is boots on the ground. Keep in mind that the pirates are sitting on (at least) 2 million barrels of crude. Enough to despoil a good chunk of the African coastline for a very long time.

Rare earth wars?

An interesting article from the Sydney Morning Herald regarding Hyundai. HY is the fifth largest producer of cars globally. A solid Korean company. Of interest is that the company changed its articles of incorporation last Friday in order to:

"secure resources for the development of eco-friendly vehicles."

This of course means rare earths, in particular neodymium. A spokesman had this to say about the company’s objectives:

“We will make efforts to vigorously secure rare earths and other rare resources used in cars."

Over the years I have done a fair bit of business with Korean companies. A part of their success is their tenacity. They won’t quit. Someone described it to me once:

“They are like rhinos. When they decide to go in one direction, they put their head down and just charge through the bush until they have arrived at the destination. It isn’t pretty. Anything in the path is trampled; the animal often suffers injuries in the process. But they will die trying to get there”

When a Korean company with a $40b market cap decides it wants to “vigorously secure rare earths”, look out. It will happen. If the 5th largest auto company is doing this, you can expect that some of the bigger players are soon to follow suit. If you followed that logic you would have to ask, “what’s GE doing in this?” Their wind business is booming. They must be one of the largest end users of REs as a result.

I don’t recommend individual stocks. That’s a good way to get egg on my face. For what it is worth I do own some of the dozen or so names that are connected to the RE story. I’m not buying more. It looks to me that we have some mining stocks that are trading at internet type multiples. Caveat emptor on this.

Big, big money is going to be made on REs.  Hyundai’s move just tripped off round two of this story.


Note: I’m nutty enough to have walked around a “likely” location looking for a meteor fragment. All you need is a stick and a neodymium magnet or two. Tape it to the end and poke it around and hope you get lucky.


There are dozens of sellers online. They don’t cost much. For $20 you get what you need. Beware. These things are incredibly powerful. I have busted up a few fingers and nails just prying them apart. And don’t even think of putting it next to a cell phone. When you see just how strong these things are, you will understand what all the fuss is about.

G20 Whacks the US & ABC News did it!

G20 “Wordsmithing”

I was hoping for some fireworks this weekend at the G20. I thought that this would be a perfect opportunity to roast our boy, Ben Bernanke. At this point in history the question, “Is US monetary policy contributing to global political instability?” has been asked and answered. The answer is “yes it is”. The only question is to what degree. I was expecting that this issue would be put on the table rather firmly by the economic leaders of the world. That didn’t really happen. Or did it?

The wording of the final communiqué (they spent most of a night drafting “acceptable” language) has some words that seem to be directed at Ben/ the USA: (Note: I edit out some the verbose language. Full text here)

We stressed the need to reduce excessive imbalances.

Interesting. This sounds like it is (as usual) directed at the Chinese. The G20 agreed to come up with specific targets regarding those “excessive imbalances”.

We agreed on a set of indicators that will allow us to focus on those persistently large imbalances which require policy actions.

Very interesting. What is suggested is that there will be names and numbers established as to who actually has these “excessive imbalances”. This information is supposed to be made available at the next G20 in April. The G20 gives a hint on who will be on that list. The first category is:

(i) Public debt and fiscal deficits; and private savings rate and private debt.

That category has little to do with China. This is directed squarely at the USA. The second category appears to be pointed at the Chinese:

(ii) and the external imbalance composed of the trade balance and net investment income flows and transfers.

What the grunts at the G20 argued about for 12 hours is which would come first (i) or (ii). A shot at America, or a shot at China? America came first.

Both (i) and (ii) were mushed together with this:

Taking due consideration of exchange rate, fiscal, monetary and other policies.

To me this suggests that the G20 is equally upset with the US and China. China’s exchange rate policy now ranks the same as the USA’s fiscal and monetary policies as disruptive "excessive imbalances". As well it should.

No one really cares about the G20 meeting and their limply worded communiqué. But it would be a mistake to ignore these signals. Over the next few months we will see more of this. The leaders of the world will be pointing their finger at the US for the problems that are exploding. The “excess imbalances” of fiscal and monetary policy in the USA will trump the exchange rate abuses of China.

Whether this is right or wrong is irrelevant. It's going to happen. When it happens, this stink will force a change in US monetary policy. (the fiscal side can’t be fixed short-term). In my view this means that QE3 is dead on arrival. If Bernanke tries to play this card the world will rise up against him. Obama will have no choice but to agree. If he wants to retain his role as a world leader.

Want some proof of this thinking? Down toward the bottom of the communiqué was this.

5. We discussed concerns about consequences of potential excessive commodity price volatility and asked our deputies to report back to us on the underlying drivers and consider possible actions.

There are many causes of the commodities price explosion that we are witnessing. At this point it is impossible to not include US monetary policies as a contributor. There will be a report out to that effect before the next G20. That’s in April. Not so long at all. Interesting to me is that this is exactly the time frame that Bernanke MUST give us some information on his next policy step. His hands will be tied.

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ABC Done Hosni In??

I have been blaming Ben B for a fair portion of the problems in the Arab world. He deserves some heat. But so does ABC news.

That Hosni Mubarak and his family looted the till in Egypt is a surprise to no one. The question is, “How bad was that rip off?” In the early days of the crisis in Cairo information came to light that the amounts involved could be between 40-70 billion dollars.


I was staggered by this information. It implies that Hosni is worth more than Bill Gates (57b) and Warren Buffet (45b). This was not some feathering of the family nest. The suggestion was that this was the crime of the century. The prior record was Madoff, but that was only $20b. No wonder the crowds went wild. This comes to nearly $1,000 per person. It is twice the entire external debt of the country.

So where did the estimate of 40-70b come from? ABC News. They did it on 2/2, very early on in the Egyptian crisis:

I have been waiting for some confirmation of this story. There has been none. The ABC News story is not correct. On Friday the Swiss government released information regarding the holdings of the Mubarak family holdings in Swiss banks. The report was oddly worded (typical Swiss obfuscation): (WSJ 2/20/2011)

ZURICH -- Switzerland has frozen tens of millions of Swiss francs in assets belonging to members of the former Mubarak regime in Egypt.

Bern said late Friday that it had blocked "several dozens of millions of francs" belonging to figures associated with former Egyptian President Hosni Mubarak

Two things on this. (1) When the Swiss say it is “several dozen million” they are talking about an amount that is less than $30mm. (2) While it is likely that additional money will be found in Swiss banks, it is not going to take the total up by a big amount. The Swiss government has this number to the penny, there will be no significant surprises. If the Mubarak money in Switzerland is less than $50mm there is no way the total could add up to $70b.

The most significant clarification comes from non other than ABC News. Their top investigative reporter, Brian Ross had this to say on 2/11:

I can tell you from personal involvement that Ross is an SOB, he also gets his numbers right. The initial reports by ABC on 2/2 were way out of line.

Would it have mattered if at the beginning of the crisis in Egypt that information on his wealth outside the country were accurately reported? Maybe. I think so.

You hear a lot of criticism about the financial blogs. That there is information that has not been properly vetted. The funny thing is that this criticism always comes from the mainstream media. Nothing could be farther from the truth. In the case of Egypt, ABC’s faulty reporting contributed to a change in government.

Big day at the WSJ & Other ‘tin hats’

Mark your calendar. 2/18/2011 might well be a day where history takes a turn. Something that I have been waiting weeks for has finally happened. The Wall Street Journal has written an editorial that is critical of the Fed and its reckless monetary policies.

To be sure this editorial is mild in its language. But when the Journal says things like this it is time to take notice:

Once again the Fed seems to have worried about deflation long after the threat had passed and even as price pressures from its easier policy were preparing to build. Let's hope it turns out better than it did the last time.

The timing of this is also important. Bernanke is in Paris this weekend at the G-20 party. He is going to get his head bashed by a number of other attendees. The WSJ has just given them the ammo they need. At this point not even the Journal has anything nice to say about Fed policy.

I think we might see a bit of a floodgate on this. Others in the MSM are watching global inflation perk up and cause big problems. They will be pointing their editorial finger(s) at Ben. Soon. Fed bashing is too much fun, after all.

It will be interesting to read the next article by Jon Hilsenrath at the Journal. He has been a steadfast Ben supporter. That crowd is getting smaller by the day. Maybe Jon will hitch a ride on a different (more popular) theme. I can’t wait.

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Speaking of those folks wearing tin foil hats, I know a bunch of them. This group is convinced that the real problem we face has nothing to do with climate change or the economy. It’s solar flares that are going to do us in.

I tend to worry about things that can actually be changed. Things that are out of our collective control are not worth fretting about. If we are going to get hit on the head with a meteor (or solar flares) there is not much we can do about it, so why worry?

There might be some worrying this weekend. Some big flares are in the works. They had a minor consequence on Chinese radio last night. A picture of the light show in the Alps and a video from NASA on the flare that caused it:

 

NASA video link

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An update on a lawsuit between the Justice Department and AMBAC. This has to be one of the nuttier stories around. The IRS “mistakenly” paid AMBAC $700mm as a “tentative” refund resulting from a big restatement of prior year income. Now the IRS wants it back. But AMBAC is in the hands of the Wisconsin insurance commission. So DOJ is suing the State of Wisconsin. I’m no lawyer, but I know a few of the rats. They tell me the IRS will win this one. Wisconsin/AMBAC will lose.

Here’s the rub. AMBAC is insuring a mere $225b of municipal bonds. (8% of all issuance) If they lose the fight with the IRS the will have no equity to pay claims. So the bonds will come into question.That's a lot of bonds.

Will the pending blowup at AMBAC be the straw that breaks the muni market’s back? I don’t think so. But there is a lot of ‘straws’ on that camel right now. The poor beast will most certainly feel the weight of this one.

This stuff can only happen in America. The DOJ suit may well force a broader bailout of the muni market. One step forward, two steps back.

A link to the 2/9 filling by DOJ. I liked this language:

40. Defendants’ conduct is causing irreparable injury to the United States, and the United States has no adequate remedy at law. Defendants’ conduct, unless enjoined, may cause a substantial loss of revenue to the United States Treasury, specifically a potential $700 million federal tax liability that may be rendered effectively uncollectible except from the non-existent assets of the Segregated Account.

Silver Tales

Nice move in silver today. We are now in uncharted waters. I think what happened long ago with “Bunky” Hunt was just noise. We are at the high. This was going to happen sooner or later, so no big surprise. I do wonder, “Why today?”

The inflation numbers were a tad hotter then expected. The news from the Mid East was unsettling. I heard some guys talking on TV that those stories are what made silver yank higher. I doubt that.

Gold was up only .7%, silver +3.6%. The currency markets did not move much and bonds were up 10 ticks. Today just happened to be “silver day”. For sure the background story was all about the upside. Even guys like me have been writing that backward = bullish.

I think today’s move was a big spec (or two) putting real money on the table getting long (or longer). Keep in mind that silver is not such a big contract. There are (at least) two-dozen names that have the ammo and the balls to kick silver up a few notches.

The March and May contracts both traded actively and ended at 31.74. This means there is no cost to roll a position. I clear incentive to get long. For leveraged players the “no carry” trade is a place to go.

I like this result. The market(s) have been way too quiet of late. A win for the hot money in silver will just create the opportunity to lean on some other vulnerable market that is set for a nice move. Gold and crude sure come to mind. Long bonds of all stripes are on the list.

Speaking of crude, look what is being paid for physical delivery down in the Gulf. The WTI is simply not telling the story of what energy is costing us. $4 gas is staring us in the face with this crude cost:

 

Old Story

For about a year or so back around 84 I ran Citybank’s (now C) bullion vault at 399 Park Avenue. This was just a corporate screw-up. The guy who had management responsibility for the vault got transferred to Hong Kong and so there was a hole in the Org Chart. I was running other profit centers and that was working out so they gave me another. Fortunately for me there were two guys who ran the vault and did a fine job at it. There was a lot of money to be made receiving/storing/shipping bullion.

One of the things I did was take people down to give a tour.  It was a pretty good show. In my mind's eye it was as big as a basketball court. There were sections that had gold and palladium. Tons of it. But the staggering thing was the silver. It was piled in 200lb bars up to ceiling. They moved it with big forklifts. Hard to describe the scope of it.

This was Bunker Hunt's silver. It was a good chunk of the 100mm ounces he bought.

The Hunt story blew up in late 79. Keep in mind that numbers then are like today except add another zero. Citi was a very big lender to the Hunts ($115mm). First Chicago was out $70mm. National Bank of Dallas had syndicated a loan for $450mm. All the banks had a chunk of that swill. The worst part was the broker loans. Pru Bache had margin loans of $200mm Hutton another $100mm and the idiots at Merrill had a $500mm out on margin.

So this was a systemic problem. (Again, a rounding number today)

Paul Volker had taken over the Fed just a few months before all this happened. Inflation was raging at the time. It was his intention to shut that down and he ultimately did. And along the way he killed the Hunts. He also killed the banks that financed the Hunts. He told the banks to eat the losses and store the silver until it could be sold without consequence. Volker played hardball with the likes of Walter Wriston, and they all backed down. Paul made his “rep” at the expense of the Hunts.

The run up in silver (and gold) made Volker look bad. The PMs were the daily signs of his inability to rein in inflation. So he crushed them. Volker set the stage with this one. It was understood that he was not to be messed with. Later he crushed the bond market. All that because inflation got a bit out of hand. Funny how history keeps coming back at you.

So that’s my Bunky story. I’m sure that there are still mountains of silver under Park Avenue. But all that Hunt silver is long since gone by now.

One Saturday morning at 4 am back then I get a call.

Are you BK?  
Yes.

Do you work for Citybank?  
Yes.

Are you the guy responsible for the bullion vault?  
Yes.

There has been an accident. The Number 6 southbound local train has derailed at 53 and Lex. The lead train crashed into the wall. The crash has set off every alarm in your vault. The noise is deafening. What should we do?  
Call the police!  

This is the police!

It took hours for me to figure out how to turn off an alarm system on a Sunday morning. The cops were pissed. Just old stuff...

Backward Silver & Forward Weather

 

BACKWARD

To make a point on silver I show the spot and forward swap prices for AUDUSD.

Now look at 1 year Treasuries and the same maturity for Australian federal paper.

Put it together. The interest differential is 4.61% in favor of Australia. Note the swaps are at a discount, meaning the left side (bid) is lower than the right side (offer). The forward Aussie discount is equal to the interest differential. Take the mid point of the swap (.0453) and divide it by the spot (.9965) and you get 4.50%. (the 11bp is spreads, ‘noise’ and basis risk differentials.)

Conclusion you can take to the bank: The forward price is equal to the interest differential. Simple.

Okay, with that in mind look at silver today. The futures price is trading to a discount to the cash price. Go back to my example for the AUDUSD. For silver to be backward it MUST mean that the cost to borrow silver is GREATER than the cost to borrow dollars. This is one of those ‘red flags’.

My conclusion? There is a shortage of the physical metal. Blame it on whoever you like. The Mint, the JP Morg, underwater producers. There are dozens of suspects to consider. Either way, it’s bullish for the price.

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FORWARD

There is some fairly conclusive information that short-term weather patterns are changing. The evidence is in the most recent ENSO numbers. The extreme La Nina conditions that have brought so much pain to Australia (and other parts of the globe) are in the process of abating.

Consider first this chart that tracks the La Nina El Nino cycle. We have moved off the trough set in December. (From NOAA web site)

The updated (December-January) MEI value has strengthened slightly to -1.62 standard deviations after almost dropping below -2 standard deviations in August-September.

The -1.62 still represents a strong La Nina. A closer look at conditions in the four regions that make up the index shows what's going on:

This shows the cumulative change in conditions. We have backed off the extreme.

Where are we headed is the question. There are many computers looking at this and many possible outcomes. A chart of the various forecasts:

Note that the projections broadly point to a reduction of the current conditions. Some of the models are even pointing to a reversion to El Nino status by the end of the summer.

Should a +.05 /+1.0 ENSO (modest El Nino) be the reality this fall it would create conditions not unlike 2004 -2005. Those two years were the biggest hurricane years in the past 25.


Quite a number of folks have suggested to me that ENSO is just part of the picture and I over emphasize its importance in short-term weather patterns. Fair enough. Yet I keep getting hit on the head with evidence that confirms to me that this cycle is driving most of the short-term results. Consider what has happened in Australia over the past six months. They got rain like rarely before seen. What was happening to La Nina conditions that most affect their weather (Nino 3.4)? This from NOAA:

After a drop to +2 in June, July rebounded to +20.5, followed by values between +16 (November) and +27 (December), including +20 in January 2011. The last time that this index showed higher values for the average of any six months was during the same half-year in 1917(!), so any SOI-based classification would classify this event as one the second-strongest event of the last century

The 100-year La Nina was the cause of the 100-year rainfall. For me the cause and effect is too clear to miss. The questions to ask are, a) why are we seeing the extremes? and b) why is the life of the cycle(s) getting shorter and shorter? To my knowledge the folks with the computers haven’t figured that out yet.

Cuts that Kill

This morning employees of community health centers across the country got this email:

“Today’s decision by House appropriators to cut $1.3 billion in funding to Community Health Centers levels a devastating blow to Americans who are already struggling in the economic recession. If this cut were to be approved, it will mean that America’s Health Centers will lose the capacity to serve 11 million patients over the next year, with well over 3.3 million current patients losing their care within the next few months.”

I happen to know a Doctor who runs one of the larger health centers on the east coast. She's been at it for a long time. I cut to the chase and asked if this means people would die:

Will people die unnecessarily? You better believe it.

All programs are at risk. You think folks are pissed off now, if these cuts go as written, it’ll be a disaster. It’s going to be a very ugly couple of years.

Well there you have it. A credible voice says people will die as a result of belt tightening. The rubber just met the road.

I’m not smart enough to know what should be cut and what should stay. I do know that cutting a billion here or there on the 15% of the discretionary budget is not going to do a thing. These are rounding errors that are being played with.

The President’s budget is a joke. If we follow that path of trillion dollar deficits we won’t make it another five years without an explosion. A big one.

There is no way we can avoid that fate unless Medicare, Medicaid, Social Security and the military come on the table. The President didn’t even address this 85% of the budget. Like the Doctor said: It’s going to be a very ugly couple of years.