On Crooks and Crooks?

This guy’s a crook and he’s going away for a very long time. His sentence will be announced tomorrow. He’s looking at 50 years. This is Lee Farkas. He was the boss at Taylor Bean & Whitaker (“TBW”). Farkas and some of his pals at TBW have been convicted of $3b in mortgage fraud.

This is a very nutty story. For me, the Farkas conviction is a sideshow. What I want to know/understand is how some of the biggest players in D.C. were involved in this mess.

Bloomberg has a detailed recap of the story. (Link). My take and some of their cuts:

This all started way back in 2002. TBW was doing big mortgage business with Fannie Mae. And guess what? Fannie determined that TBW was selling phony loans. Fannie accused TBW of fraud. They looked at specific mortgages and concluded:

A public records check revealed that the named borrowers didn’t hold title to the real estate and that the mortgages sold to Fannie Mae had never been recorded, according to the Fannie Mae document.

In 2008 a Fannie Exec said this about the events of 2002:

“Our conclusion was that fraud, if I can use that word, had been perpetrated on Fannie Mae, and we considered that to be a very, very serious matter.”

As a result of the fraud Fannie stopped doing business with TBW. But they had a side deal to keep that quiet. Why? Because the disclosure would hurt the mortgage pool. Unbelievable!! From a court document:

Fannie Mae wanted to preserve the value of the servicing portfolio, which would plummet if it reported that Taylor Bean was selling bogus loans.

So after Fannie sneaks out of this dirty deal, who steps into the trap? None other than those idiots at Freddie Mac: (from the Bloomberg story)

At Freddie Mac, the decision to boost purchases from Taylor Bean was made by David H. Stevens, then a senior vice president of mortgage sourcing.

This insanity led to the $3b ultimate fraud. How could this have happened? Fannie knew that TBW were crooks. They must have been laughing in the halls when their archenemies at Freddie picked up where they left off. Who was in charge of Fannie at the time? Who was it that failed to notify ANYBODY of mortgage fraud? None other than Franklin Raines.

So what does are boy Frank have to say about the events that took place in 2002? Unbelievable!

“I have no memory” of the Taylor Bean matter.”

This just might be one of those cases where water boarding might be justified. He has no memory of such a significant event? Not possible.

Fannie and Freddie were regulated by OFHEO in 2002. Armando Falcone was running the place at the time. He was a Clinton holdover. I’m not sure what role he played in this. I find it impossible to believe that the “Top Cop” of the GSEs was not aware of the history of TBW. I think he tried to force the issue and got fired for his efforts.

On 2/25/05 this notice of a new requirement for the GSEs to disclose any evidence of fraud was published in the Federal Register. Falcone was behind this disclosure effort. He had to have something in mind.

Six weeks later Falcone was forced to resign. He wrote a letter to Bush.

 
I wonder if this sentence was a hint of what he was thinking:

I expect Fannie Mae and Freddie Mac will ultimately emerge as more effective and responsible government-sponsored enterprises.

I take this to mean that he did not consider Fannie and Freddie to be either effective or responsible. He knew they were rotten.

So who takes up OFHEO in 2005? Does it surprise you that it is George Bush’s lifelong friend (and school mate) James B. Lockhart?

Consider the circumstances. Lockhart comes in over the fraud disclosure issue. He must know that this is the hot button. It’s the reason he has the job! Does he do anything about it? Is he not aware of what happened with TBW and Fannie? Is he not aware that Freddie is buying billions in loans from TBW?

Lockhart does nothing and the opportunity for massive fraud on the people has been assured.

Now consider the role of a central player in all of this. David Stevens. He was the SVP at Freddie that made all of this happen. He left Freddie in 2005. Right at the time that Falcone was pushing for fraud disclosure. David had a fine career at Wells and Long and Foster where he continued to be a big shot in the mortgage industry. His chance to really shine came in 2009 when he was appointed head of FHA:

So what does our boy David do less than two months after taking on this big job? He blows up TBW:

David had to know all along that TBW was dirty. Give the guy some credit. Back in 2002 he gets a call from TBW where 100% of the new business is being offered to him. He knows that TBW is a big customer of Fannie, but he never asks why the switch? Not in a million years.

Mr. Stevens just got another big job. He’s out of government, but he hasn’t left D.C. Today he is running the Mortgage Bankers Association.

Quite frankly, this whole story makes me want to puke.

Obama and the IEA - Egg on the face

On June 23 I wrote about the Obama/IEA decision to intervene in the global crude market. I hated the plan. One of the points I made against it was this:

Is (the IEA intervention) about teaching a lesson to OPEC? I am concerned that this is a factor. The US wanted OPEC to up production. That didn’t happen. So the bad boys who produce oil just got a shot across the bow.

Watch if this angle on the story gets “play”. It would piss off those bad boys and they will retaliate. Does O really think he can take on the world oil market?

-OPEC will respond. “We” will pay a price for this.

Bloomberg has a story out just now that Saudi Arabia is not so happy about this and some cut backs in production just might be in order. From the article:

Oil rose in New York, extending the biggest gain in six weeks, amid concern OPEC may reduce output in response to the International Energy Agency’s move to release oil stockpiles.

“If IEA countries are releasing stockpiles Saudi Arabia won’t increase production as much as expected,” said Hannes Loacker, an analyst at Raiffeisen Zentralbank Oesterreich in Vienna.

“There are concerns Saudi Arabia will cut production” in response to the IEA move, said Roland Stenzel, an oil trader at E&T Energie Handelsgesellschaft mbH, said from Vienna.

Oil is on a tear as a result of this (and other factors). If the end result is that OPEC cuts off production by a percent or two the ultimate cost to global consumers will be measured in the hundreds of billions.

I also said this last week. I’m now certain that I was right:

-Obama will get some egg on his face with this one.

Obama, Democrats, Republicans AND Bernanke All in a Bind – What they will do and when

We have two distinct groups in D.C. that are stuck between a very big rock and a hard place. The first is the Federal Reserve. The second is the Democrats and Republicans and the battle being waged over the debt limit. I see a possible solution to these impasses. It’s so simple that I’m sure it is being considered. The prospect is scaring the crap out of me however.

The Fed is in a bind. The economy is clearly slowing down again. Unemployment will soon follow. According to the Fed’s Dual Mandate they should be doing something about that.

They have few options. They can’t do more Large Scale Asset Purchases (“LSAP”). What has become referred to as “QE”, has not worked. It was also very unpopular (both in and out of the country). LSAPs may come back sometime, but they are on the shelf for at least a year. What could the Fed do in the near future?

I) They could increase the inflation target (core CPI) from “A little under 2%” to “A tad over 3%”.

II) They could alter the ZIRP (zero interest rates) language from: “For the foreseeable future” to: “Until such time as the Fed’s new inflation target has been achieved but not less than one year”.


These relatively minor changes would have very dramatic effects.

-Inflationary expectations would jump. Actual inflation would follow.

-The dollar would crap out. Exports would increase.

-This would result in wage pressure. Exactly what the Fed wants.

-The resulting inflation in all commodities would roll into new home construction costs and therefore be a boost to existing values. (Soft bailout to housing/lenders)

-It is (short-term) supportive of equities. Exactly what the Fed wants.

-Debt costs can’t rise too fast as ZIRP keeps the belly of the curve cheap. This has to happen. Without LSAPs,  this is the only way to achieve it.


Are you scared yet? Now consider where the politicians are on the inflation story.

Republicans have drawn a line in the sand on the debt limit with their position of “No New Taxes”. The Democrats have said pretty much the opposite with, “No spending cuts”.

Neither side appears to be giving an inch. There is no common ground. Yet, to go to August 2 without a resolution is just a dumb move. Both sides of this big debate know that the next presidential election is riding on the outcome. If the US is to default; one side or the other will shoulder the blame. The “side” that gets the blame will lose the election. And both sides understand this. So where’s the compromise?

The solution is inflation. The government has got to get out of its inflation indexed obligations. You don’t have to raise tax brackets to raise revenues or cut expenses. You can mess with inflation adjustments to achieve these ends. Both sides can appear to win if this is accomplished.

Consider the words last week of Brian Graff of ASPPA (Lobby for pensions and actuaries) (The conference was sponsored by the IRS!!)

"Eliminating indexing is one of the proposals receiving serious consideration as Congress enters “uncharted territory” with legislation to raise the debt ceiling, If Congress were to stop indexing for a period of time, which would affect tax brackets, individual retirement account contributions, and contribution limits under tax code Section 415, “you could raise a lot of money, and those are the kinds of things they are talking about.”

On the expense side of the equation a great deal of fat can be cut by eliminating/cutting COLA increases in a variety of programs. The most important of which would be Social Security. Depending on how the cuts in COLA are defined and how they are applied a huge amount of money would be saved over an extended period.

If all social obligations had their COLA increases cut in half it would (on paper) put the US on a much more solid long-term footing. It is a very appealing “kick the can down the road” approach. No cuts in programs (just smaller increases) and no new taxes (but higher revenue as the inflation adjustments for AMT and other tax issues kick in).

If you buy into this thinking this is they way it could play out:

We DO go to the 11th hour on the debt limit. But a compromised is reached. Central to the deal is a broad restructuring of the way inflation impacts both revenue and expenses at the federal level. Both sides claim victory.

Two months later Bernanke will announce what will be called QE3. He will make a long-term commitment (at least one year) to maintaining interest rates at near zero levels. And he will raise the inflation target that the Fed is hoping to achieve by 35% ('smidge' over 3% core CPI)

Should things play out along these lines it will be sea change series of events. If anything like this were to be in our future the very worst financial position would be short gold and long bonds. Being short volatility in any market would also be a mistake. Outside of that, I’m not sure where/how to position for this.

My thoughts:

Deflation is scaring us to death. But inflation will kill us. And that is exactly what the ‘Deciders’ have in store for us.

Big O and the IEA - WTF?

I’m surprised by the move by the President and the IEA. What’s this about?

Is it about the price of oil?

Before the announcement WTI was sitting around 95. That’s a solid $20 lower than it’s peak eight weeks ago. Why would Obama & IEA act today? A very big price adjustment has already been made. If the circumstances were different and the price of WTI was through $120 I might have agreed to this. But why make a splashy show now when no show is required?

There is more to this than meets the eye is my conclusion.

Is this really about Libyan production? 

On a global basis I don’t think this sells. Japan’s slowdown offsets most of the Libya loss. Anyway, the Libya story is two months old. Why the action so late in this game?

Is it about punishing speculators?

Obama promised to do this. I thought he delivered on his promise when the CFTC started raising margin requirements willy nilly.  But direct intervention in the crude market? That is raising the ante by a great deal of chips.

The driving force in the drop in crude over the past month or so has being the growing realization that the global economy is hitting multiple speed bumps.

Not to be boring, but China, Japan, Europe and the USA are all slowing down. What “specs” out there were swimming against that tide? Not many, in my opinion. So if one of the objectives was to beat on the players I think this move missed by 90 days. IMHO this silliness is setting up a great buying opportunity. So the specs are going to cash in when this washes out.

Is it about teaching a lesson to OPEC?

I am concerned that this is a factor. The US wanted OPEC to up production. That didn’t happen. So the bad boys who produce oil just got a shot across the bow.

Watch if this angle on the story gets “play”. It would piss off those bad boys and they will retaliate. Does O really think he can take on the world oil market? He can’t beat the Taliban. OPEC will crush him.

Is it about stimulating the US economy?

This seems to be a significant part of the equation. But just think this through. The rule is that for every $1 drop in crude we see a 2-cent drop at the pump.

Say for the sake of it that this drama will result in a $10 drop in crude. So the pump goes down by a lousy 20 cents. Do the deep thinkers really believe that if gas gets twenty cents cheaper for a month or two that they have really bought themselves anything?  Are things so desperate that steps not taken before are justified? That’s a conclusion the stock market was pondering today. The bond market ran up the same flag.

Is it about stimulating China or Europe?

That can’t possibly be the case. The 60mm brls represents just 16 hours of global consumption. If it’s stretched out over 30 days it comes to an insignificant 2% of daily demand. That is a super tankers worth. There are hundreds of ships at sea right now with that much crude on them. This has nothing to do with influencing global supply.

Is this a desperate move by the administration to show leadership?

I looked at the WH home page and did not see this important development highlighted. Maybe the big O is trying to distance himself on this one. I’m convinced this will backfire. Give it two months. Tops.

Are supply and demand conditions such that this extraordinary move is justified?

Beyond the already discussed Libya non event I’m not aware of something that is blowing up in one of the big producers. Does Obama have some insight on this? Does he know something I don’t about Iraq, Iran, Venezuela or Nigeria? Stay tuned. If something blows in one of these over the next few weeks you will see how things are orchestrated.

Is this a big deal?

On the numbers; no it is not. But it is one of those sharp right hand turns that come up from time to time. Because it is so unusual it bears noting. We live in an  interventionist world. Every aspect of the global economy is trying to be manipulated by the “Deciders”. I have never seen a precedent like today. In that sense, I consider this to be a very big deal.

Are we going to see more of this type of market intervention?

I’m sorry to say that we might. What’s been offered up is a drop in the bucket. So round two of this foolishness is a distinct possibility.

Did Bernanke know this was coming when he spoke with great confidence that oil prices would soon retreat?

This took months to put together. Bernanke knew it was coming. We live in a manipulated world.

My thoughts:

-This was a bonehead move that was put together by Euro technocrats. They dreamt this up two months ago. It was a dumb plan to offset the consequences of Libya. Because 30 countries are involved it took sixty days to ink an agreement.The timing today is a mistake.

-Mr. Khadafy is pissing many folks off at this point. He should be gone by now. Look for Mr. K to get a cruise missile up his arse any day now. 

The principal rationale for this market intervention is Libya. Take that out of the equation and there is no justification left for continued meddling in global markets.

-This one trick pony is going to knock 15 cents off the price of gas for a month or so. There will be a disruption in market liquidity and inventory levels. This will result in a big spike in crude sometime this fall.

-OPEC will respond. “We” will pay a price for this.

-There will be technical problems at the SPR. They will not be able to deliver 1mm barrels a day of light sweet crude.

-Obama will get some egg on his face with this one.

Europe's Problems - US Money Funds and Politics

It’s been my thinking that the US financial system is somewhat immune to the unfolding events in Europe. To be sure, there are some potential losses. And should Europe screw up in their efforts to kick the can down the road, there would be economic consequences. Europe would slow down, that would impact the rest of the globe. But no systemic crisis. That kind of thinking is “out there”. The US has an ocean in between the storm that is brewing.

That may not be the case. Fitch did another of its reports on US Money Market exposure to European banks. (Link to Fitch, but you have to sign up to see the info) . From the report:

Over the past three months, MMF exposure to European banks has been stable, at roughly 50% of total MMF assets.

Huh! 50% is a very big number!

Where is that MMF exposure concentrated? Its mostly in the Core countries:

What banks are dependent on US MMFs for dollar based financing? The list:

My thoughts on this:

When I look at the list of banks and the countries that they are domiciled in my first thought is;

“Don’t worry. These banks WILL NOT default on short-term IOU’s to US MMFs.

So what did I do after coming to the conclusion that this was not a solvency issue and that I needn’t worry about it? I took a decent chunk of money out of MMFs. I bought Bills.

What I’m concerned about is a liquidity problem. And while I am as sure as I can be that those MMF assets are “money good” I just don’t want the hassle and aggravation if one of these funds “Breaks the Buck” (even if it is just for a short period of time). I was earning 1/8% or so on that idle money. I do not take any risks when the return is that low. (Screw you ZIRP [and the Fed] on that one)

There is a better than 50% chance that the wheels just keep coming off in Europe. If the outcome continues to deteriorate this business of the US MMF is going to go mainstream (this has been brought up recently by Jim Grant and a few others). It would only take one fund someplace in the world to go to 99.9 for there to be an issue.

I still say it would not be a true/lasting crisis. What would happen ASAP is that the Fed would open the swap windows with the European Central banks. They in turn would provide the needed dollar liquidity and that would pay down the MMFs.

But wait a minute. The numbers here are at least ½ Trillion. That would be perceived as a Mega Bailout. Something like this would create a fire storm in American politics. This would not be a TARP situation, but I don’t care. That is how the vast majority of Americans would look it at. 

US Bails Out European Banks would be the headline.

We’re not far off from something like this occurring. Like I said, it doesn’t take much for people to head for the exits these days. I already did.

Senators Graham, Paul & Lee on Social Security Reform– “If you're under 47 - bend over”

Three heavy hitter Republican senators have put forward a plan to restructure Social Security. Lindsey Graham (R-SC), Mike Lee (R-UT) and Rand Paul (R-KY) have sponored the Social Security Solvency and Sustainability Act, S. 804.

Overall, I give this plan a “C”. That grade is composed of two distinctly different analyses. On the pure question of economics, I give the plan a “B”. But on the more critical issue of “Is this fair” I give the plan a “D”.

Given that the proposal has some positive economics attached to it I think that something along these lines is what me might see if Congress ever got around to doing its business of passing legislation and fixing problems. I believe that if this plan were pushed to a vote it would get support from some Democrats and actually has a chance of passage sometime in 2012. The reason that there might be some Dems who cross the aisle to vote for something like this is that the structure of the proposal is very much a “Kick the Can Down the Road” approach. All politicians love that way of thinking.

The issues at Social Security are easy to define. It’s the Boomers that are the problem. The solutions are also relatively easy. Benefits can be cut, or taxes can be increased. A very convenient way to cut expenses is to just increase the age for eligibility by a few years. The critical questions are (1) when do these changes take place and (2) what age group is going to get screwed as a result.

Some details of the proposal:

A) Gradually increase Social Security’s full-benefit age starting in 2017, from today’s age 66 to age 70 for Americans born on or after 1970.

B) The legislation would increase the early-benefit age starting in 2021, from today’s age 62 to age 64 for taxpayers born on or after 1966.

C) Gradually change the benefit formula starting in 2017 so that upper-income Americans would start to receive smaller benefits while benefits for those with lower incomes would remain the same. These changes would become fully effective in 2055.

The financial health of SS is measured actuarially. This science looks at projected income and expense streams over a 75-year period and draws some conclusions. I don't see a better way to evaluate this mess. But I’m convinced that it is a flawed analysis. No one has the slightest idea what the world will look like in 50 years. And more importantly, the problems for both the broad economy and society that SS is bringing us have a window of only the next 15-years or so. It’s my opinion that if the USA does not address the imbalances that are currently impacting SS we will not make it to 2025. The system  will sink from the weight of these UNFUNDED liabilities.

Clearly Senators Graham, Paul and Lee don’t see it that way. The vast majority of those who do pick apart the numbers would agree with them. So I'm a bit out in left field calling for a blowup. I will say that if one did adopt the 75-year measure of financial health, the proposals put forward in S. 804. would, in fact, move the needle in the right direction.

The plan does not include any increase in taxes on worker's or their employers. To me, this is essential. SS is already sucking up 12.4% of worker's income. That’s too much. If anything the program should be scaled back so that the contributions are lowered. Under no circumstances should they be increased.

The Senator's proposal increases the socialization of the system. I think that is essential. Workers with high lifetime earnings will be subsidizing those who had low lifetime earnings. Call this a tax on the rich. I don’t see anyway around this.

Increasing the age limit is something that significantly improves the financial profile of SS. It looks like an easy way to push the numbers around. That’s true, but it’s not without consequence. I would point to the riots in France just two years ago when the retirement age was increased. Who were the protesters? A coalition of younger and older workers. The older ones had obvious reasons. The younger ones were brought to the streets because they desperately wanted the old folks to retire. Why? Because they wanted the jobs that would become vacant. Youth unemployment in France is north of 20%. That is exactly where it is headed in the USA. So raising the retirement age “fixes” SS but it also closes some doors for younger people all the way down to their early 20’s.

For these reasons I give that favorable “B” grade (there is no “A”). But now consider who is getting screwed.

The Baby Boomers will reach age 65 in 2011. This population bulge will continue to hit the SS system until 2029. Note this. We are on the very first rung of a very tall (and shaky) ladder.


The problem for SS over the next 20 years (and a Medicare in a bigger way) is the Baby Boomers. When you look at the age group that is causing the problems and overlay the proposed changes you see that the Boomer contribution to the “fix” is not very much at all.

(a) Increasing the age limit to 70 after 2017 only impact those born after 1970. So the Boomers get a free ride.

(b) Increasing the early retirement age is limited to only those born after 1966. Another miss.

(c) Changing the benefit formula starting in 2017 would hit the boomers (At least it would on paper). But the phase in of this takes place over 40 years. The Boomers will be dead and buried before the actual hit takes place.

So who are the losers in the Graham, Paul, Lee plan? The answer is that anyone born after 1966. If you’re younger than 47 today, bend over. The Boomers are going to screw you. You’re going to pay more than you should and you’re going to get less than the boomers got.

How could that possibly happen? Easy. It’s the demographics. Those who will “win” this age war out vote those who will lose. There are some very powerful lobbies at work as well. The AARP has a very big stick; they use their weapons on the Pols very effectively.

I will be sad if this comes about. This would be the greatest “Pass the Trash” for any generation in history. While the proposed changes would take SS off the discussion table for another decade or so it will come back into the headlines in a very big way at some point. There is absolutely no fairness in a plan that protects Boomers at the cost of the rest of society.

I think that in their hearts, Senators Graham, Paul and Lee don’t really believe in SS and would like to see it go away. It is, fundamentally, a socialist approach and it does suck up a huge amount of current tax revenue. But even these powerful Senators can’t kill SS. If their proposals are adopted it would destroy Social Security. Ten/Fifteen years from today public support for SS will have completely evaporated. It will just take that long for those younger generations to realize how badly they got set up.

I’m a cynical guy. I think that Graham, Paul, Lee (and all the others) understand that they are lighting a slow burning fuse on a very big bomb with plans like this. But they want to keep their jobs, power and influence, so they don’t do the right thing. They propose to kick the can to another few generations.

Color me disappointed. Especially with Rand Paul.

Japanese and US Stocks - The Bernanke Footprint

It’s been noted by many that the USA is eerily following the path of Japan. The similarities are there. A mature economy, aging population, huge debt to GDP, massive unfunded liabilities and a stagnant economy. Both countries have chosen to address their structural problems with more and more debt and cheap money monetary policies.

A friend sent me the following chart that looks at the Japanese stock market and the S&P. Two important adjustments have been made to the data. (1) There is an eleven-year lag on the Japanese Nikkei. (2) The data is currency adjusted. I think this is a pretty scary stuff:

These lines do not match up perfectly over the measured period. But what is striking is the correlation of the “Turning Points” in the markets. Look at how it lines up in the most recent period. The S&P appears to be rolling over the past six weeks. Exactly as the Nikki did eleven years ago. But look at the results. In the eleven years that followed, Japanese stocks fell from the index level of 200 to the current value of 76. That is a 60+% drop!

There are differences between the US and Japan. So this chart may not be our future. But if it is even remotely close then the US will not make it another eleven years. Something will blowup in a spectacular way.

I found this chart fascinating, so I looked a bit deeper to see what Japan has done and why. Guess who played a big hand in determining the monetary policy of Japan? I’m sure you guessed this one right. It was none other than Ben Bernanke. He gave a major speech way back in 2003 on what Japan should do. If you’re a Fed watcher read the whole thing. My take on it was that Ben was lecturing to the Japanese Central Bank. If you found the above chart a sign of what is in our future Ben’s words eight years ago will give you the Willies.

The Intro:

My remarks today will be focused on opportunities for monetary policy innovation in Japan, including specifically the possibility of more-active monetary-fiscal cooperation to end deflation.

BK: If you took out "Japan" and inserted "America" this would be the same speech that Bernanke would use today. He has taken the same attitude in all of his speeches since 2008.

The “Ben” plan

I will discuss the option of asking the Bank of Japan to announce a quantitative objective for prices, as well as how such an objective might best be structured.

I would like to consider an important institutional issue, which is the relationship between the condition of the Bank of Japan's balance sheet and its ability to undertake more aggressive monetary policies.

BK: Bernanke has pushed for a Fed policy that targets inflation. He has brought us QE that has added to the Fed balance sheet. Ben’s plan for Japan is what we have in the USA today.

Ben’s philosophy

In principle, balance-sheet considerations should not seriously constrain central bank policies.

BK: They shouldn’t be “seriously” considered?? OMG!

The Bank of Japan should consider increasing still further its purchases of government debt, preferably in explicit conjunction with a program of tax cuts or other fiscal stimulus.

BK: That is exactly what happened in 2009. We got ZIRP, QE1 and HERA (tax cuts and stimulus).These things have had no lasting impact.

From the point of view of conventional private-sector accounting--which, as I will discuss, is not necessarily the correct standard in this case.

BK: Ben thinks Central Banks are above the “rules”. We certainly have that status today.

On the issue of Monetiziation

A tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

BK: Note the “financed by money creation” part of this. Ben swears he is not creating money today. But that is exactly what he proposed for Japan AND that is exactly what he is doing in the US today.

On the "Goodness" of more debt

Ben asks:

Isn't it irresponsible to recommend a tax cut, given the poor state of Japanese public finances?

And answers:

To the contrary, from a fiscal perspective, the policy would almost certainly be stabilizing.

BK: NO! The consequence is destabilizing. The real consequence is that people (markets) lose confidence when money is cheap and governments are running printing presses.

Ben admits to a downside

Of course, one can never get something for nothing; from a public finance perspective, increased monetization of government debt simply amounts to replacing other forms of taxes with an inflation tax.

BK: This drives me nuts. Bernanke has been pounding the table that his monetary policy does not cause inflation in the US and the rest of the world. But Eight years ago he saw the connection perfectly. Today he is in denial. Either Ben’s lying to us, or he has his head in the sand.

H/T:JH

African Land Grab - "Acres for a bottle of Scotch"

Everyone who eats is aware that agricultural prices have been on a tear the past few years. With this has come a sharp increase in the value of arable land. Deep topsoil farmland in Iowa has changed hands as high as $11,000 an acre recently. That’s up from about $6,000 just a few years ago.

The shortage of arable land has gone global. Africa has seen an explosion of activity since 2008. How big is the land grab? Who’s doing the grabbing? It’s hard to tell as there is no central source of information and many of the transactions are not made public. An outfit called the Oakland Institute has been compiling information on this. From their June 8 press release:

The scale, rate and negative impact of land deals is alarming. In 2009 alone nearly 60 million ha– an area the size of France – was purchased or leased in comparison to an average annual expansion of global agricultural land of less than 4 million ha before 2008.

Consider these three maps. They describe the scope of what has happened in Mali, Sierra Leone and Ethiopia.

The total in these two countries alone is 460k HA or 1.14 million acres. How big is that? Big. This is an area the size of Rhode Island, It is about 80Xs the size of Manhattan. But this is small beer. Consider what is going on in one of the poorest countries in the world, Ethiopia:

The total of 5.3mm acres in just this one country is equal to the size of New Jersey. It's the same as the combined area of both Connecticut and Delaware. If you’re thinking of a European comparison this is equal in size to about half the land of Switzerland, Denmark or the Netherlands. It’s equal to all of Israel.

Who’s playing in this big land grab? Hedge funds and other speculators are big, so are a number of US Universities. From The Oakland report:

Western firms, wealthy US and European individuals, and investment funds with ties to major banks such as Goldman Sachs and JP Morgan.

Surprised that Goldie and JP are involved? I’m not. Some other players:

Several Texas-based interests are associated with a major 600,000 ha South Sudan deal which involves Kinyeti Development, LLC, an Austin, Texas-based "global business development partnership and holding company," managed by Howard Eugene Douglas, a former United States Ambassador at Large and Coordinator for Refugee Affairs.

A key player in the largest land deal in Tanzania is Iowa agribusiness entrepreneur and Republican Party stalwart, Bruce Rastetter, who concurrently serves as CEO of Pharos Ag, co-founder and Managing Director of AgriSol Energy, CEO of Summit Farms, and is an important donor to the Iowa State University.

Major investors in Sierra Leone include Addax Bioenergy from Switzerland and Quifel International Holdings (QIH) from Portugal. Sierra Leone Agriculture (SLA) is actually a subsidiary of the UK based Crad-l (CAPARO Renewable Agriculture Developments Ltd.), associated with the Tony Blair African Governance Initiative.

Are the African countries getting a square deal? Not even close:

In Sierra Leone official regulation requires investors to pay $5 per acre, or $12 per ha, per year.

In Ethiopia, Karuturi initially received land for just $1.25 per ha, the rate was later raised to $ 6.75 per ha. In comparison, rates for Brazil or Argentina are $5,000-6,000 per ha.

I loved this quote from Oakland:

“The research exposed investors who said it’s easy to make a land deal – that they could usually get what they want in exchange for giving a poor, tribal chief a bottle of Johnny Walker.”

I suppose that some good could come from all of this. Clearly there is going to be a very big push for agribusiness in Africa in the coming years. This would suggest that a new food supply is coming to a hungry world. It also suggests that there are going to be jobs and opportunity in the countries involved. I doubt that this will happen in the way the land grabbers are thinking. I’m sure that the likes of Tony Blair and Bruce Rastetter will do just fine, but the pensioners and LP interest are going to get clobbered when history repeats itself in Africa. At some point the locals are going to say “No”.  At $2 an acre and a tax holiday to boot I wouldn’t blame them.

How Hedge Funds ride herd in America

Let me try to connect some dots. I think this adds up to an interesting comment on how things get done in the good old USA. This example does not pass my “smell test”.

Start with something called a “Safe Harbor”. This is a legal designation that is established by the IRS. The activities of entities inside the Safe Harbor are free from taxation. The critical variable in determining whether Safe Harbor status is granted is if the activities of those seeking tax-free status are conducting trade or business in the USA.

I will go you two extreme examples. Toyota, a foreign corporation, has plants and retail outlets in the USA. They are clearly conducting trade or business here. No Safe Harbor status for Toyota. On the other extreme consider an individual in Europe who owns some US Treasury securities as a passive investment. They are not conducting trade or business, so the interest income is tax-free.

These two examples are pretty clear-cut. The problem is that everything in the middle of these two extremes is not so clear. Those who want the benefits of tax-free status, but have a question mark as to whether they in fact deserve the favored treatment, have to petition the US IRS and get a letter ruling to clarify their status. If they get a favorable ruling, they are off to the (tax-free) races.

Next consider this article (Link) from the NY Times June 8th. This article discusses a new phenomenon in US finance. Hedge Funds are becoming lenders. They are acting as banks. They have customers, they loan money to them. This is becoming a big deal. From the article:

Hedge fund managers have been called plenty of names. Now, they can add another: local banker.

Middle-market companies, which generate $6 trillion in revenue a year and employ 32 million people in the United States, are borrowing billions of dollars from the hedge funds for product development, strategic acquisitions and even day-to-day operations like payroll and utilities.

Okay, we have two distinct issues. Safe Harbor status and hedge funds who are actually bankers. Now the dots that connect these two.

Consider the role of Managed Fund Association (“MFA”). MFA is the D.C. lobbying arm of the hedge funds. They make that pretty clear in their web site:

MFA is the voice of the global alternative investment community. Our members are professionals in hedge funds.

So what is MFA doing to promote business and make money for the hedge funds? They are doing everything possible to get Safe Harbor status for inward lending to the hedge funds for offshore money.

Hedge funds want to make loans to US companies; they will finance this activity with untaxed money from abroad. Consider this letter (link) sent to Treasury (the IRS) by MFA on 6/1/11.

From the letter:

For the reasons discussed below, we respectfully request that guidance under section 864(b) of the Internal Revenue Code be included in the forthcoming 2011-12 Guidance Priority List.

MFA continues to be concerned that the absence administrative guidance under section 864(b) of the Code concerning whether certain activities by otherwise passive non-U.S. investors, including (but not limited to) activities involving the acquisition of loans and other debt securities as well as the receipt of certain types of fees, will be treated as falling outside the safe harbors.

The guidance can be issued in the form of clear safe harbors and there is no doubt that guidance of the type requested will reduce the potential for burdens on, and controversy between, the IRS and taxpayers.

What’s this about? Hedge funds who make loans need financing for the loans. They have no deposit base, so where will they get the money to make the loans? The answer is: From offshore. The process of raising money is made much easier and cheaper if there is a private letter from the IRS that insures that the activity of offshore lenders is deemed tax free in the USA. That’s why the big push from those nice folks at the MFA.

Here’s the rub however. Community banks in the US pay income tax on their lending to US customers, and so do US investors in bank loan mutual funds, partnerships, etc. So the proposal by the hedge funds (MFA) would give them a leg up against traditional lenders. They would get a tax break on their activity, while everyone else would suffer.

What’s the downside to giving tax breaks to hedge funds? From the NYT article:

These lenders typically charge interest rates that are several percentage points higher than banks.

The lending force also poses a significant risk to the companies and the broader economy, given the unregulated nature of this shadow banking system.

Another worry is that funds will trade on nonpublic information they receive as lenders. A March study in The Journal of Financial Economics found a spike in investors betting against the shares of companies that took hedge fund loans.

My bet is that the hedge funds and the MFA will get their way. Another big tax break will be created that benefits few and costs everyone else a bundle. How could that possibly happen? Easy. The hedge funds have clout, and they are using it:

MFA members include the vast majority of the largest hedge fund groups in the world who manage a substantial portion of the approximately $1.9 trillion invested in absolute return strategies.

If you want a good example as to why the recently passed FINRA legislation is just a joke, this is the perfect example. If you have money and power in this country you can do damn near anything you please, and you can also do it without paying any taxes.


Notes:
-Lending activity within our boarders has always been deemed as conducting trade or business. So this carve-out for hedge funds constitutes a significant change in policy.

-The powerful NY Bar Association has weighed in on this issue and fully supports the position of the MFA. Why? Because the NY lawyers would make a bundle promoting and setting up the safe harbor activity. Can you say “enlightened self interest”? The  NY Bar on this topic (link).

Bernanke – “There is no inflation”

I listened to Big Ben yesterday and what I heard is guy who is on the defensive. He spent most of is talk describing in some detail why the Federal Reserve and its cheap money policies of ZIRP and QE have not added to the inflation picture.

IMHO Ben should have stepped up to the plate and said to the world that in fact his policies have contributed to inflation. He should have confirmed, what we already know, the objective of current monetary policy is to stimulate inflation. After all, the idea that zero interest rates do not contribute to inflation is, well, a dumb idea that has no basis in fact.

While Ben was doing his best to convince the suckers that believe in his drivel the NY Fed was publishing a blog that concluded quite the opposite. (Link)

The title of this chart from the report says it all:

The report looks at what is rising in price. It equates it to what we actually consume. For example, while the fact that Tenant’s Insurance has fallen in cost is important to the CPI, it has little to do with what we actually spend money on. The conclusion from the NY Fed:

84 percent of all expenditures in the CPI basket were on items that experienced above-average increases in inflation in the last seven months.

The bottom line is that Ben can’t fool me. He can’t fool the economists at the NY Fed. He can’t fool the market. So just who is he trying to fool? I think he is trying to fool himself.

Smoking is bad for your health - Tobacco bonds will kill you

I think tobacco bonds are headed into the crapper. There’s about $56b of them out there. Most of that is either in retail hands or in bond funds that retail owns. This is likely to be a slow motion train wreck rather than something that explodes into the headlines one morning. But it will put a dent into some 401Ks. It already has.

By way of background on this let me diverge a bit and give you my side of the tobacco story. I knew a fellow who was a mover and shaker in one of the big US tobacco companies. Back in 1998 the tobacco companies reached what appeared to be a very harsh settlement with the states. The essence of that deal was that big tobacco would fork over a huge wad of money and the states agreed not to sue for healthcare claims. At the time the deal was inked I had a conversation with the guy. It went something like this:

BK: Man you guys took it in the ear on this one. Good-bye dividends, goodbye profits. You guys got smoked!

Lucky Strike: You have it totally wrong. This is a great deal for us. This is exactly the deal that we hoped to achieve when we started this out. It looks like we are big losers, but in fact, we are big winners.

BK: Huh? That’s not what it says in the papers. They say you will have to fork over ¼ trillion over the next few decades. How’s that such a good deal?

Lucky Strike: You have to understand, there was a real possibility that tobacco would become a controlled substance. If that had been the case we would have folded the tent in the USA. But with this settlement we are guaranteed to be in business forever, and we are shielded from liability. We made a pact with the devil. In this case, the State Treasurers are the devil.

BK: I don’t get it. Sure there is a new source of revenue for the states, but there is also the increased medical cost that goes with it. Where’s the Beef?

Lucky Strike: This deal allows the states to securitize the future revenue from this settlement. That means they can issue new bonds but they don’t have to show it in their debt profile. The tobacco settlement is just a way for the states to get off balance sheet financing. The guys on Wall Street are already ginning this up. The states can issue billions of new bonds. The current crop of “Ins” will spend it. We used the State's greed to get what we wanted.

BK: But this is all going to blow up if the states do that! Ten – Fifteen years from now this is all going to come due. What happens if they hock the future settlement proceeds and then we find that there are no proceeds?

Lucky Strike: If that were to happen it all goes Boom. But I’m retiring in five years and those that inked this deal from the states will be gone before the flameout. In the meantime everyone is fat and happy.

BK: Oh. So that’s how things work.

Note: A lot of readers have said that I dwell on the ‘dark side’. It’s true. Stories like this one are the reason why. It’s not nice on the dark side. But when it comes to politicians, money and Wall Street you’re safer with the dark view. You don’t get surprised as much by what happens.

Back to June of 2011 and the cracks on all this are starting to appear, Some quotes from a recent Bond Buyer story:

The payments that cigarette manufacturers make to the states are dwindling as people smoke less, posing the latest setback to tobacco bonds.

“We saw a consumption decline that was above and beyond our base-case expectation,” said Aoto Kenmochi, a tobacco bond analyst at Fitch Ratings.

The precipitous decline in payments threatens to leave some tobacco bonds outstanding longer than expected. In the worst cases, the withering payments could eventually push some bonds into default.

Fitch has downgraded dozens of tobacco deals as the fading settlement payments have left tobacco structures with less of a cushion to tolerate further erosions.

Here a few charts on some outstanding tobacco bonds. If you want a high current yield this is for you. But beware; you may never get your principal back.

You can see from the pricing that these dogs have already been hit hard. More bad news is in front of these bonds.

The worst of the worst is the following. I have this on my Piece of S#*! list. Consider the insanity of this. Back in 2008 the State of Michigan borrowed $58 million. They spent this money the very next day. This is a zero coupon bond so Michigan doesn’t have to pay a penny until the maturity. The maturity was FIFTY YEARS!!!! The principal due at maturity? An unbelievable $4.4 BILLION. And there is not sufficient revenue to cover it. Note: This piece of crap is in pension fund hands. Talk about kicking a can down the road.

Social Security - The Liberals are killing it!

I have several dozen articles relating to Social Security over the past three years. They all say the same thing. The Social Security system was dealt a hammer blow by the 08-09 recession. At this point there is no possibility that the SS program can be stabilized without significant and prompt action to address the underlying imbalances. Failure to deal with the problem in a timely way will result in a systemic problem for the US economy in less than ten years.

While there are a number of proposals to address the imbalances, there really are only two possible out comes. Either the 60-70% of the baby boomer population who are highly dependent of SS are going to have the benefits cuts, or younger workers are going to have to dig into their pocket to pay for the Boomers for the next 30 years.

Bottom line; either a significant portion of seniors are going to be eating cat food, or the next few generations are going to be paying (unfairly) through the nose.

I have not written one of these critical pieces without getting a bunch of complaints from the big guns who support  SS (as it is) and maintain that what I am saying is just bunk. They are wrong, I’ve been right all along.

Charles Blahous, the Public Trustee for the SS Trust Fund gave testimony (Link) to the House Ways and Means Committee on Friday. I think he laid it on the line rather nicely.

The 2011 Trustees’ report is the first in which Public Trustees have ever participated to have concluded that an era of permanent annual deficits has been reached.

This is important. It’s all you need to know. SS has turned a corner. It is headed south. It will continue to head south as far as the broader economy is concerned for the next 75 years (actually SS is in perpetual deficit).

Social Security expenditures exceeded the program’s non-interest income in 2010 for the first time since 1983. This deficit stood at $49 billion last year and is projected to be $46 billion in 2011.

These are not small numbers. The $100b shortfall in 2010-11 is a fairly big burden given that the rest of the government’s finances are in such a hole. Blahous said something that may have been a “tell” as to what we are looking at in the future with these deficits:

This deficit is expected to shrink to about $20 billion for years 2012-2014 as the economy strengthens. After 2014, cash deficits are expected to grow rapidly as the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers.

Blahous is not following the SS “script” with this comment. These are the projected deficits based on the SSTF annual report:

Note that the “projected” annual deficits remain fairly small all the way out to 2018. So what is Blahous referring to regarding big deficits post 2014? SS provides an alternate forecast that they call the “High-Cost” analysis. This chart looks at the two forecasts together.

For Blahous to suggest to Congress that the deficits will be “growing rapidly” post 2014 represents (to me) that the real thinking inside of SS is that the actual results will be closer to the worst case scenario. Should that be the result, the cumulative deficit at SS from 2011 through 2020 will be a very lumpy $900 billion.

My own review of the numbers says that we have little chance of achieving even the results of the high cost analysis. It is likely to be much worse than that. The problem is that the economy is simply not producing enough jobs. There are fewer workers contributing to the system. The SSTF is anticipating “a strengthening economy”, I see no evidence of this today and have no expectation for a turnaround in the jobs picture any time over (at least) the next five years. The following graph says it all on payrolls in America. The recession killed us. As of today the number of workers contributing to SS is less than it was in 2000. Look at this at you will understand the problem.

I think that Blahous made some important comments. One’s that will shut up the defenders of SS. The argument that those defenders repeatedly use is that SS does not impact the current deficit. That is flat out wrong:

Social Security operations are currently adding to the unified federal deficit and will add substantially more in the years to come.

The facts folks. SS is adding to the annual budget deficit ($116b in 2011). It is adding to our funding deficit (the amount we need to borrow from the Public). That number was a manageable $49b in 2010 but it will grow every year from now on. In less than a decade it will become unmanageable.

Blahous spoke about the “Assets” of the SSTF. The believers in SS constantly point to the huge $2.6T surplus at SS and say: “There is plenty of money in the piggy bank. There is no need to mess with SS today”. That is not the case at all.

If we look at the bonds from the perspective of the Trust Funds, they are assets. If we look at them from the perspective of the unified federal budget, they are a net wash, as are the interest payments that they receive.

Folks, there are no Assets in the Trust Fund. There are pieces of paper to be sure. But they are just pieces of paper. The merely represent claims on future taxpayers.

The following words are, I think, critical to the debate on SS:

The costs that will be borne by younger generations will grow significantly each year that a new cohort of baby boomers joins the benefit rolls.

I am screaming at the top of my lungs, “How can we let this happen?”

To me, it is absolutely insane to think that the Baby Boomers (I’m one) can put the burden of SS on younger workers. This simply will not work. The result of a policy approach that sticks everyone under 50 with the cost of the Boomers is going to result in deep social divides. We have enough problems in our society today. We don’t need/want Age Warfare to be added to the list. But if the plan to “fix” SS is one that sticks the bill onto young people we WILL have age warfare, it’s inevitable. The social consequences would be greater than the economic costs. Why does no one see this?

Addressing the imbalances at SS will be painful, and no one likes pain. So the result has been that our political leaders just kick this can down the road. I don’t think that there will be any fixes at SS until after 2012. While an extra two years will not result in a crisis, it will result in a higher cost of the necessary fixes. I hope all the defenders of SS read what Blahous has said on this:

Elected officials will best serve the interests of the public if financial corrections are enacted at the earliest practicable time.

Earlier action will also afford elected officials with a greater opportunity to minimize adverse impacts on vulnerable populations, including lower- income workers and those who are already substantially dependent on program benefits.

The big defenders of SS call themselves Liberals. Paul Krugman and Dean Baker are on top of the list. But there is nothing liberal about their position. Who is going to be most hurt by what is coming (absent changes)? The answer is clear. Older people who are 100% dependent on SS and younger workers who are on the bottom of the income scale.

The Liberals have to come to understand their dilemma. The more they put their foot down and demand no changes to SS, the worse off will be those that they are actually trying to help. The liberals are shooting their own constituency. 


Note: On these matters I consider myself a liberal. But I come to a completely different conclusions than those who actually call themselves Liberals.

My position on this complicated issue:

-We can’t cut benefits across the board. Too many people would be eating cat food. That’s not American.

-We can’t put the burden of the Boomers on younger workers. It’s simply not fair. That’s not the American way either.

-The solution(s) have to be born (largely) by the Baby Boomers themselves. Post the Boomers, SS can be a PayGo concept. But the transition is not PayGo. It is a huge inter-generational transfer of wealth. This means that well off Boomers (there are many, including myself) are going to have to dig into their pockets to support those in their age group who did not fair so well. That, in my opinion, is the only viable solution. That would be more representative of the American way. Fairness.

QE - A failed policy

After the lousy NFP numbers the media ran a few stories on what a miserable failure QE has been. David Faber over at CNBC did a pretty good job. Tyler Durden at Zero Hedge had this to say (Link). A smart fellow I know sent me some charts on this line of thinking. Bottom line; If you exclude the fact that QE did juice the stock market, it did nothing measurable for the real economy. The reason that we will not see QE3 (IMHO) is that even Bernanke knows, QE didn’t do shit.

The follow charts look at various indices of economic activity and tracks them against a basic measure of QE; the size of the Fed’s balance sheet.

Housing

The early portion of this housing price chart appears to track the implementation of QE. Don’t be fooled. That temporary increase in prices was attributable to first time buyer tax breaks. It’s clear that those fiscal incentive just stole from future consumption. After the tax breaks expired housing prices resumed their decline. QE had nothing to do with the blip back in 09. QE2 accomplished nothing at all for the slump in RE.

GDP

In this chart I see no evidence that QE1 (and especially QE2) had any measurable results on economic growth. The GDP increase in 2009 was a consequence of ARRA (the $800b stimulus program). As the spending waned, so did GDP. Government spending does directly contribute to GDP growth. QE had little or no effect at all.

Jobs

The Fed may well use a chart like the following in an attempt to prove they moved the needle on employment. Recall that the census hiring was the cause of the spike in jobs back in March/June of 2010. I would argue that the very tepid increase in jobs over the last year is attributable to people being forced to take work they don’t want rather than true/healthy job creation.

If Bernanke ever did try to defend what he has done as being "pro jobs" I would snap back with the following chart showing where we have been and where we are now. The bottom line on jobs is that for all of the trillions in government spending and the huge increase in the Fed’s balance sheet we are still only back to levels of employment we saw ten years ago. (That housing prices (on average) are also back to 2000 levels is no coincidence.)

 

Stocks/Commodities

Both Bernanke and his ace boy, Brian Sachs, have repeatedly said that the best measure of the success of QE is the impact that it has had on equity prices. The correlation to the expanding balance sheet of the Fed to the higher S&P is 85% R^2. Based on that, one can safely assume that cheap money does support higher stock values. I say, “Who cares?” The graphs above all show that nothing positive has happened in the real economy. The benefit of higher stocks has a very limited impact on consumer spending. Yes, stock ownership is fairly broad. But for most folks with a 401K it just means they have recovered a portion of their retirement savings they lost a few years ago. The top 5% in the country have a made a bundle. Like I said, who cares?

I'm hoping that Bernanke does try to use the “QE is good for stocks” argument one day. It will blow up in his face is if he were to try. That correlation between stocks and QE at 85% is matched perfectly with the correlation between QE and the rise in commodity prices. So really what QE brought us is that the fat cats of or society got, well, fatter, while the other 95% of the population was stuck with the bill for higher prices of everything we consume.

 

Note: The charts for both stocks and commodities have had their lines crossed of late. That is a very big red flag.

MISERY

I think this chart says it all as far as QE goes. The rise of QE and the rise of food stamps are lock stepped. Can you say failure?

 INTEREST RATES and the FUTURE

This last chart has a question mark on it for good reason. It looks at the QE time period and tracks the performance of the ten-year bond against the S&P. Note the near perfect correlation between the announcement of QE 1 and 2 and bond yields. Rates go up when we have QE, rates go down when there is no QE. How to read this? Does it mean that without daily QE  the economy will fall flat and yields will fall? Or does it mean that the ‘market’ is so afraid of the implications of QE (monetization) that when the policy is in force players hate bonds? I think it could be a bit of both.

Note that at the end of this chart there is a divergence developing. That divergence started exactly when Bernanke announced that QE was over. That is no coincidence. It has been my observation over many years that the bond market is a better predictor of the future than the stock market. The bond market is giving some very heavy signals that it sees trouble ahead. One thing you can count on. This divergence will not last for long. Either interest rates are going to rise in the coming months or stocks are going to take a hard whack.

 H/T Johan