Congress Sics IRS on “Enemies”

I was thinking of writing a book. “The Coming Age Warfare”. If I did get around to it, the following story might be the first chapter. Like most wars, the one I see coming between young and old will simmer for years. Along the way there will be skirmishes that result in injury and bad feelings. I find this example comical. But there is nothing funny about it.

Three members of Congress have shot a cannon at the American Association of Retired Persons (AARP). Republicans Herger (CA), Boustany (LA) and Reichert (WA) sent a letter to the head of the IRS asking that the tax status of AARP be reviewed.

AARP is a 501(c)(4). That means they pay no taxes at all. Sort of like a church. At first look this might make sense. After all, the AARP is a non-profit that is just trying to help out the oldsters. Right?

Wrong! AARP took in $600,000,000 during 2010 from endorsement deals. Not a penny of taxes was paid.

Anyway, the AARP fired back with a (mealy mouthed) letter the next day:

AARP Response to Recent Letter from Reps. Herger, Boustany and Reichert

We are disappointed that the letter seeks to decry the exact kind of pro-consumer, market-changing efforts that AARP has led since our founding in 1958.

You can bet the folks over at the AARP are “disappointed” that some congressmen have sic’ed the IRS on them It’s worth $150mm a year to them.

I wouldn’t worry about the AARP just yet. They have an army of political friends and some big shot lawyers. It’s a safe bet that the IRS sits on this until 2013 when a (potentially) new IRS Commissioner has the corner office. In the meantime, one can expect that the AARP will direct their campaign investments contributions wisely. They will support those candidates who will push to preserve the cushy tax status of the AARP.


Note:
This business with tax breaks for the AARP (and other big 501(c)(4)s) is another good example of how screwed up our tax laws are. The current system just creates carve-outs and preferences for powerful groups. Why? The answer is that those same powerful groups have control over the outcome.
.

2012 - Things that will happen

Significant economic and political changes will make 2012 a historical year. The globe has experienced relative calm for the past 24 months. That stability won't last much longer. Events that are not on anyone's radar screen will matter the most. The following are the things that I think might happen, but it's the surprises that worry me.


-Silas Kiplagat will win the 1500-meter race at the Summer Olympics in London. The time will be 3:33:22.

-Obama will drop Joe Biden from the ticket. Obama will want a Veep that has a chance to be a viable presidential candidate. He will chose Hillary Clinton.

-Green Bay will beat Denver in the Super Bowl. (Millions of Christians will be disappointed).

-Mitt (the suit) Romney will be the Republican presidential candidate. The nomination will be a fight to the very end. Newt (the fool) Gingrich will come close, but will not get the nod. Romney will announce that his running mate will be South Carolina Governor, Nikki Haley. Her presence on the ticket will give Mitt a chance.

-Ron Paul will run as a third party candidate (Green) He will get 10% of the popular vote. He will upend any chance the Republicans have.

-The presidential election will go to Obama. Ending up with only 44% of the vote, he will not have a mandate.  The battleground states will be Pennsylvania and Ohio. Billions will be spent on getting the votes in those states. Pennsylvania will go to Obama. Ohio will go with Romney. The electoral vote margin will be very narrow as a result.

-The Kepler spacecraft (link) will identify a planet that has the capacity to sustain life (the ultimate safe haven). The scientists at CERN will confirm the observation  of particles exceeding the speed of light. These developments will result in significant rethinking by the scientific community.

-The Senate will be split evenly between Democrats and Republicans. The new VP will have deciding votes on several key issues.

-Republicans will retain their majority in the House. Gridlock will be the outcome. There will be no new legislation of significance in 2012. A lost year.

-Iran will attempt to disrupt sea traffic in the Straits of Hormuz. Naval exercises by NATO, USA and China will be required to escort tankers through troubled waters. There will be an incident culminating in shots being fired. It will scare the hell out of everyone, but full military action will be avoided.

-Iraq will fall into sectarian violence. Car bombings will beset the country. The Kurds, in the north, will attempt to separate themselves from Baghdad. Turkey will get involved as a result of border problems. In the south (Basra/oil ports), the local Shia government will ask neighboring Iran, to help bring stability. The Iranians will establish a police presence.

-Brent crude prices will swing between a low of $80 and a high of $155. The highest level will be reached in September.

-Australia will suffer from a significant economic slowdown. The A$ will fall to 90 versus the buck.

-Cyprus will make a significant new gas find. This will result in territorial claims by Turkey. The UN, lead by Russia, will get involved in the dispute.

-Europe’s economic problems will not be solved. Every effort will be made to kick the can down the road. Neither the can nor the road will collapse; that will happen in 2013. EU GDP will struggle to hold zero.

-It will be confirmed that Iran has nukes and the capacity to deliver them. Iran will successfully test fire a Shahab 3c missile. Israel will not attack Iran.

-The US housing market will stabilize. Rental costs will rise by 7%. This, coupled with extremely low debt costs, will increase the demand for homes. In addition, the costs of constructing new homes will soar due to rising costs of materials. Virtually everything used to build a home (from cement to shingles) will rise in price by 10%. Construction of new homes will remain muted as a result.

-During the year, the ECB will be forced to actively intervene in the EU bond market on multiple occasions. Ten-year yields for Italy will range from 5 to 8%. Spanish yields will rise to 10% at one point. French bonds will reach 7%. The enormous refinancing requirements of EU countries and banks will be a constant problem. The market will become obsessed with the weekly bond auctions. There will be many disappointing results.

-The EU banks will struggle, kept alive by LTROs and E150B of new equity injections into the banks (a la Tarp). Public assistance to the banks will exceed E1 Trillion. The EU banks will not adopt the Basel Core Tier 1 capital ratio of 9% in June; the planned recapitalization will be shelved for a year.  There will be much discussion about the scale of the government's involvement, which will be recognized as unsustainable. By year's end, the noose will be tighter and the financial options greatly diminished. By December 2012,  the Euro Zone won't be expected to survive another year.

-The Swiss National Bank will maintain the 1.20 peg to the Euro. By the end of the year, the talk will be about how much longer the peg will continue. The SNB will acknowledge that the peg was a temporary measure. The speculation will be about how long “temporary” actually is.

-The Euro will range from a high of 1.4 to a low of 1.15. The low for the year will occur in November.

-The Yen will (finally) weaken. The low for the USDYEN will be 76.5 the high will be 90. (It's a great short). The problem for Japan will be its 200% debt to GDP. Global investors will shun the Japanese bond markets. Ten-year yields will rise to over 2% as a result. While Japan has gotten away with its excessive debt for years and global investors always had reasons to park cash in Japanese Government Bonds (JGBs), there will be no reasons left in 2012.

-As the US's presence in Afghanistan winds down, the Taliban will retake the country. The chaotic US exit will be compared with the end of the Viet Nam war.

-The Syrian government will fall. The country will face an uncertain future. There will be sectarian violence in Libya. Sophisticated weapons, including SAM missiles will be used. In Egypt, Field Marshal Tantawi, will consolidate power.  Protests will continue throughout the region. The MENA economies will broadly suffer.

-The S&P will range from a low of 900 to a high of 1400. The high for the year will occur before June.

-The US GDP will languish. Growth will range from 1.5 to 2%. There will be clear evidence of a slowdown by mid-year. Unemployment will fall to as low as 8.5%, but will end the year back above 9%. The BLS will report 1.6mm of new jobs created during the year but the "birth/death" model will reduce that by 600,000. Labor force participation will continue to decline.

-Modest economic activity and core inflation above 2% will tie the Federal Reserve’s hands for the first part of the year. Politics will prevent it from acting prior to the election. In December of 2012, the Fed will be free to initiate another round of QE -  an $800 billion Large Scale Asset Purchase (LSAP) will follow. The Fed’s new POMO operations will be divided equally between Treasury bonds and Agency Mortgage paper.

-The Vix will be volatile. The average for the year will be 30. It will exceed 45 twice.

-Greece will continue pretending it wants to be in the EU and tied to the Euro, until July. Its deteriorating economy and inability to service its restructured debt will force Greece to leave the EU and re-establish the Drachma. The New Drachma will trade as high as 1,000 to the dollar (800/Euro). When the Drachma is brought back (over a weekend), the Greeks will formally default on their external debt. This won't be the crisis that everyone fears, but it will add to the instability in the other peripherals. Populations in Ireland and Portugal will protest that their countries should follow Greece’s steps.

- The Academy Award winners:

Best Movie                      War Horse

Best Director                   Steven Spielberg

Best Actor                       George Cloony

Best Actress                    Michelle Williams

Best Support. Actor       Christopher Plummer

Best Support. Actress    Jessica Chastain

Best Orig. Screenplay    The Tree of Life

Best Adapted  "              War Horse

-North Korea will be a problematic. Counter to expectations, Kim Jung-Un will not be the actual ruler. The generals will conspire with Kim’s uncle, Jan Song Taek, to take over leadership. There will be an occasional pop shot from north to south. The real trouble will come when NK boards and then sinks a S. Korean fishing vessel. This will bring US aircraft carriers off the shores of NK. China will hate this development. A nasty incident is the most likely outcome.

-The Miami Heat will fail to make the playoffs. LA will beat Boston. 

-Keynesian economic thinking will be further discredited in 2012. The pump-priming Keynesians had their day in the sun, and now people will want a different approach. Paul Krugman will write a total of 100 blogs decrying this development. Larry Summers will write an OpEd for the WSJ warning that the US faces a strategic crisis if it does not contain the trajectory of the national debt.

-Gold will be very volatile. It will fall to below $1400 at one point. It will end the year above $2000.

-There is a significant risk of a big economic hiccup at the end of the year. The election has deferred dozens of tax/spending issues to 1/1/13. There is enough deflationary firepower built into the system to trigger a big slowdown. Post election, there will be just weeks to sort it out, or face the music. The drama and the pain of the just completed election will make it impossible to avoid a conflict.

-Japan will confront two divergent issues. Debates regarding the future development of nuclear energy for civilian use will arise as the true costs of the disaster at Fukushima are realized. Significant portions of the country will have to be abandoned. Costs of encapsulating and cleaning up will exceed $50 billion. At the same time, a growing force within the country will push to develop tactical nuclear weapons. The US's mandatory budget cuts for its military will elicit an extraordinary change which will take years to play out. Japan will lose confidence that its "protector" will be able to protect it.

-India will surprise everyone. GDP growth will fall from 9% to 3% (well under stall speed). Inflation will exceed 10%. The trade and current account deficit will rise. The Rupee will hit 60 per dollar.

-China’s GDP will fall to 4%. China has already overspent in infrastructure development. The buildout of empty cities will slow and unemployment will rise rapidly. This will stress the country and lead to political protests in many cities.

-Tiger Woods will win a major. 

-China will continue to fund the west. It will allocate more capital to the core countries of Europe. China will get trade deals in exchange for its willingness to buy bonds. The holdings of US treasury debt will decline modestly for the year. The Chinese will react to the ongoing pressure from the US to force the Yuan to appreciate by doing precisely the opposite. The CHY will be worth the same next year as it is today.

-Bank of America will be forced to pare down its asset base. The stock will spend most of the year under $5. The subordinated debt will trade cheap.

-Goldman Sachs will go private. There will be many layoffs. The Squid will end up stronger than ever.

-The San Francisco Giants will win the World Series. The Yanks will be the loser.

-In March, it will finally be determined that MF Global used re-hypothecation to fund its operations. The customer losses will be attributed to this activity. Realized customer losses will exceed $1B. JPM will be identified as one of the banks that grabbed MFG assets in the final days. Customers will file civil claims against JPM, but those will be dismissed. Criminal charges  will not be filed against MFG, Corzine nor JPM. The flaws in the system will be attributed to Reg. T. The Fed will promise a thorough review of the country’s margin rules. Nothing will be completed until 2013.

-AAPL will trade as high as $450. It will end the year under $350. The company will come out with a TV that won't be much of a success. Apple will lose out to Amazon (and others) in the "Cloud". This will prove to be a strategic error.

-The cost of solar panels will fall to a level where large scale, privately funded solar farms become viable. The debt for these farms will be functionally secured by a public utility and will be repackaged with shorter maturities that have a AAA rating. The lowest tranches of debt will have returns as high as 20%. Wall Street will love it and so will investors. Some utility stocks will do well as they have secured a source of renewable energy that meets the recently legislated requirements (RECs).

-Boeing’s shares will fall to $55. There will be problems with the Dream Liner.

-Dividend stocks will underperform the broad averages. The observation will (finally) be made that this is a very crowded trade and 2% does not compensate investors for their risks.

-Creative Cause (son of Giant's Causeway) will win the Kentucky Derby. 

-The Chevy volt will suffer from numerous battery problems. There will be fires that result in serious injuries. The future of GM’s electric car will come into question. The stock will fall to the teens. Tesla’s outlook will become uncertain. Obama’s investment in Tesla will be a campaign issue.

-La Nina conditions will persist for the first six months of the year, bringing a series of big storms to Asia. Substantial new flooding will occur in the Philippines and Thailand. West Texas will have another dry year, the central states will have above average rain, and the North East will have a very bad winter.

-Silver will follow gold up and down. It will underperform gold. It won't hit $50.

-Narco violence in Mexico will escalate. There will be gun play on the border. Mexico will reiterate its position that the problem is the demand from the gringos, not the supply from Mexico. This thinking will lead to renewed discussion on legalization of Marijuana. Phillip Morris’s stock will rise above $90 in anticipation.

-BRIC investments will continue to underperform. Several big hitters will repudiate this investment strategy. That will mark the bottom of these markets on a comparative basis.

-Global food inflation will continue to be a problem. Global growth will advance by 2%, the cost of feeding ourselves will increase by 5%. Asia/India will bear the biggest brunt of the increasing cost of food. Wheat prices will rise 12%.

-US inflation will remain on the high side. Core will average 2.5% (1/2% above the Fed’s target). CPI will come in at 3.8%. Real inflation will be much higher. Treasury Tips will underperform. The Ten-Year Tips/Coupon spread will widen to 2.75%.

-Few countries will avoid social protests and demonstrations. Many will turn violent. America will not be spared. The angst of the people will be directed at their leaders, their lenders and the IMF. A redo of 2011.




-The election will spur debate on the future of America’s entitlement programs. There will be broad based agreement that the time has come to address the problems with Social Security, Medicare and Medicaid. Politicians will try to divert the focus away from Social Security by pointing fingers at the Disability Insurance side of SSA. While it’s correct that this program is a complete disaster, the DI Fund is not the problem.  The Retirement Fund is the real problem. The attention that DI will get is just a diversion from what is actually wrong with America’s favorite entitlement program. This will be a “young” versus “old” fight. Both sides will come to understand this.

-The summer of 2012 will bring the largest polar ice melt in history. The Mayan calendar will end with no consequence.

Edna

At around this time over the past few years I’ve written about the posh holiday parties I went to. No luck this year. I went from the A-list to the Shit-list (I blame the blogging). So instead of eating fancy canapés and talking with very important people, I went and saw Edna.

Edna was born in 1918. She’ll be 94 years old in January. Her mother died young, she went to a home for children when she was eight. In 1936 the home went bust due to the depression and a shortage of donors. She has interesting stories of what it was like to live in Jersey City during the second depression of 1937. She remembers where she was when she learned that Pearl Harbor had been bombed. Her husband went to fight in Italy during WWII. She lived an average life, and enjoyed every minute of it.

Two years ago I got a call from an Emergency Room. Edna had arrived in an ambulance. She could not breathe and they were going to vent her. I thought it was over. Not the case. Five days in the hospital (steroids, oxygen, antibiotics and 24 hr. care) followed by twenty-one days in a rehab and she was back on her feet.

Edna’s medical problems were caused by old age. There is a valve that allows food and water to flow to the stomach, but blocks it from getting into the lungs. Edna’s did not work well. The result was "aspiration pneumonia". She had two failed operations operations to repair the valve.

There is a treatment for this. They poke a hole in the patients stomach, put in a tube and tie it to a bag that the patient wears on her on hip. Ensure gets fed to the patient via the bag. Nothing goes down the throat. Problem solved. Edna wanted no part of that.

Edna’s been to the emergency room/hospital a total of six times since that first episode. She averaged four days each time. She has had two operations and spent seven weeks in rehab.

The medical profession can truly work miracles these days. This woman should have been dead (at 92 years old) when she had her first episode. If this were 1981, she would died.

With each brush with pneumonia she was advised that she should opt for the bag. If she didn’t, then she would get sick again. I spoke with her about this on several occasions. She told me the same thing she told her Doctors:

No bag! I’d rather be dead then not eat or drink again!

I can’t blame her. But there is an ugly side to this. Given the cost of the treatment (100drs of thousands?) over the past 24 months there are questions that society has to ask Edna. (1) Does she have the right to say "no" to the medical alternative? (2) If she says "no", does society (Medicare pays for all of Edna’s bills) still have to pay for the repeated hospitalizations?

In 2011 the answers to those questions are "yes" and "yes". No treatment is without patient consent and every hospital would put out a maximum effort if she were wheeled in the ER door again. America can pay for Edna today. She is a very small percentage of the population. We are still a wealthy enough nation that we can afford to give Edna the treatments and the choices. That will not be the case in ten years.

America’s population is aging very rapidly. There will be a bulge over the next twenty years. I’ve looked at these numbers. They are out of control. I don’t think it’s possible that the country can provide the level of care that Edna has gotten to all of those other Edna’s out there.

The Edna story is a death panel story. It’s a horrible discussion to have. Does Edna, at 94, have the same medical rights to make choices as does a thirty year old? If you say no, how do you respond to new knees at 74 and new hips at 84? When you start drawing lines, it’s very hard to stop.

The easiest thing to do about this is nothing. No one wants to touch this hot potato. I can’t blame them. That said, in less than ten-years the question of what to do about Edna will be asked and answered. In the end “she” must lose some of her rights. For the life of me, I can’t figure out how that can be accomplished.
.

Bad Governance, Bad weather

Bad Governance

The House finally passed the lousy two-month extension of payroll tax breaks. The CBO scored the Bill that is now law. The costs for 59 days (and annualized if extended for all of 2012):

Social Security....................$19.8B........Annualized $119.B
Extended Unemployment.....$8.4B........Annualized $50.4B
Medicare...............................$3.4B........Annualized $20.4B
Totals........(two months).....$31.2B........Annualized $181.8B

The total cost of $31B is paid for with an increase in mortgage fees to be charged by Fannie and Freddie. Given that these two are providing 90% of new mortgages, most folks who buy a home or refi an old mortgage will get hit with these fees. CBO estimates when these fees will come into the Treasury.

This information raises some questions. I posed them to CBO and did not hear back.

1) The bill sucks money out those who have a mortgage. But if this method of financing the stimulus were used to cover the other ten-months of 2012 it would but a monster bite in those homeowners. It is dumb economic policy to stick it to those who borrow money for the next ten years to pay for a two-month stimulus. It is insane to think that this could be expanded to cover a full years worth of stimulus.

My point is that there is a funding hole for expanding the stimulus beyond February. We can look forward to another stupid big fight. It will be interesting to see whose pockets get fleeced next. Maybe a levy on farmers, pro athletes or even the Boy Scouts will come up for considerations. Those options are no dumber than taxing mortgages.


2) Note that the revenue from the tax on mortgages is $1.3B in fiscal 2012. Fiscal 12 ends on 9/30, therefore the tax kicks in prior to 9/30. The 1.3b is at least three months worth of revenue (as compared to full year 2013 @4.6B). Based on this information I conclude that the start date for the mortgage tax is June 1, 2012.

We have seen in the past what happens when a subsidy for housing ends. The housing market reacts pre and post the ending of the stimulus in a predictable fashion. Buyers do what they can to get a deal done before the subsidy goes away. Demand is “borrowed” from the future.

The tax on mortgages will work in a similar manner. Post 5/30, a buyer who takes out a $600,000 mortgage will pay an extra $50 a month ($6,000 over ten years). Will this influence demand on a short-term basis? I would expect so. The RE hucksters will be pushing this all spring:

“Buy Now! Close Quick! Avoid the Tax!

After 6/1 there will be a drop off in demand for housing. This seems particularly dumb to me as this will happen right in front of the election. Possibly the Republicans (the tax on mortgages was their idea) think that a weak housing market coming into November plays to their hand. I think they will end up with egg on their faces.


3) The Republican leaders hate Fannie and Freddie. The reason they insisted that the 2012 stimulus be paid for on the backs of mortgagors is that they want to force F/F out of business. I hate F/F too. But 2012 is not the time to make mortgages more expensive

The Republican Party has been digging their heels in fighting against every form of tax increase. But what do they do to achieve their objectives? They raise taxes, just like the Democrats do.

I would give the Democrats a C- grade on how this worked out. The Republicans deserve a D-. America is suffering from bad governance.

****************************************

Bad Weather

Today there are reports of 1000+ deaths from flooding in the Philippines. Last week another 750 were killed from massive floods in southern Thailand. A month ago the Thai capitol, Bangkok was inundated for a month. Deaths by drowning and water borne illnesses are in the thousands. These hundred-year floods are the result of the same weather pattern that brought the floods to Australia a year ago. La Nina conditions have persisted in the Pacific Ocean.

The following chart looks at the long-term ENSO cycles. Below zero is La Nina, above brings El Nino conditions. The data shows that neutrality in ocean temperatures was achieved in September. But today we are rapidly turning back to strong La Nina conditions. The chart shows several occasions in the past where the ENSO cycle was negative then neutral and finally negative again. It’s more normal to see a cycle shift from a La Nina to a El Nino.

Both El and La conditions bring the potential for severe weather. When the cycle persists the damage that it brings is concentrated in the same parts of the globe. This slide looks at Asia today. There are severe storms all over the region. The rest of the globe has relatively tranquil conditions.

For the US, the return of a strong La Nina means that West Texas will stay dry, above average rain in the central part of the country is probable and the NE looks like it is going to get a miserable winter; Cold and snow.

The farmers say, "A drought will scare you to death, but too much rain will kill you." As usual, the farmers are right.
.

Too Close to Home?

Two headlines. Similar stories. The first from Switzerland:

The United States authorities have offered to lift the threat of legal action against 11 Swiss banks in exchange for information, a Swiss paper reported on Sunday.

This is part of a very long story.  The US Justice Department has been doing everything it can to get the names of US citizens who have Swiss bank accounts. The DOJ damn near busted UBS over this a few years back. Now they are going after the other Swiss banks. The lawyers at the DOJ don’t kid around:

“Give us the names or we’ll sue the shit out of you”. 

Given what happened to UBS ($780mm in fines), the other banks have no choice but to fold and hand over the info.


This second story ratchets things up a bit and brings it home:(Link)

A federal district court judge has given the Internal Revenue Service permission to serve a “John Doe” summons on the California State Board of Equalization demanding the names of residents who transferred property to their children or grandchildren for little or no money, from 2005 to 2010.

The IRS has used John Doe summons to seek lists of American taxpayers unreported offshore accounts at Swiss Bank UBS and at HSBC’s bank in India.

These pushy techniques have worked  well in Switzerland.  The hard working folks at the DOJ/IRS are now bringing them to California. This means that the IRS can look at anyone’s real estate transactions. With John Doe warrants, they can go fishing/snooping wherever they like.

Think what you will of this. The country is starved for revenue. The outfit that is charged with collecting that revenue has an army of tough-minded lawyers behind it. It will have the power to turn over stones as it pleases. In the end this effort will raise some additional revenue. It will scare the crap out of a few folks as well. Some will cheer this. I see the John Doe warrants as a big and dangerous step on a very slippery slope. It sure won’t do much for Uncle Sam’s image.

Unrelated Note:

In my forecasts for 2011 I said:

-Kim Jong-Il will die. His son will take over. The heir is a nut, there will be more military exercises that results in shells landing on S. Korea soil. China will make public statements that it is trying to bring order; behind the scenes they will be applauding the chaos.

I got the first part right.  I believe I will be right on the second part too. This could get very messy. Fast.

Throw the bums out!

The bumbling fools in D.C. have done it again. They’ve screwed us all one more time. The low rent morons who are running the show have kicked the can down the road for (get this) two months.

On Saturday the Senate agreed to a bill that would A) extend unemployment benefits B) extend the 2% payroll tax deduction and C) delay a cut in Medicare reimbursement rates. The deciders agreed to do all the extending, delaying and pretending for two lousy months. In other words, Congress will be back at it over these critical issues in less than six weeks.

There have been dozens of articles from smart people connecting the dots between the uncertain tax policies business’s face and their reluctance to hire more workers. I’ve heard Pols from both sides say the same. It’s true. But the best that Washington can do is move the ball forward by 59 days; disgraceful.

The two-month extension amounts to $33b that will be retained in the economy. I would not be surprised if the benefit of the stimulus will be lost by the continued uncertainty that is being caused by D.C. What has been “accomplished” is just a loss.

The bright guys who came up with the plan have a mechanism to pay for it. They’re going to charge homeowners a new fee for the next ten years. If you get a mortgage from one of the federal agencies (90% of mtg. market) you’ll pay an extra price. It only comes to $15 a month if your mortgage is less than $220k. But if you live on either coast or in any big city, the cost of housing will force you to pay a bigger price. $45-50 a month is a more realistic way to consider the implications. What’s an extra $600 a year? It’s just another nail in the coffin for housing.

By far and away the weakest link in the economy is housing. There is not much that can be done about it. It takes time and there will be pain. But there is no excuse for congress to force homeowners to absorb the full cost of the stimulus. The legislation results in mortgagors directly subsidizing doctor's Medicare reimbursement rates! How stupid is that? What are these people thinking of? This is terrible economic policy, and every legislator who signs the Bill, knows that fact.

The problem with the legislative process in this case was the side deals that got included in the horse-trading. This time the issue was the Keystone XL pipeline. The Republicans wanted it; the Democrats opposed it. Why does the fate of the pipeline have to be tied to the fate of important economic legislation? Why can’t we have an up and down vote on issues? The Deciders lumped these two divergent considerations together and in the process shot us in the foot. We end up with another stopgap measure and few weeks before we have to do it all over. My Senator, Chucky Boy Schumer (D-N.Y.) had this to say about the conflict that is sure to come in February:

“It’s a fight we welcome”

These clowns love this stuff. It has nothing to do with the right choices; it’s about the next election. They don’t give a damn about the country or it’s citizens. It’s about keeping their powerful jobs.

I know whom I’m voting for in the next election. I’m voting against anyone that is currently “in”. I don’t care what stripe they wear. I want the other guy/gal. I’m going to vote against Chuck Schumer and all the other "ins". I want to send a message to every damn one of them. The ones who have their hands on any levers today; are no longer wanted.

Some will argue that I’m being irrational. That if enough voters thought as I do all the folks who now run governments would be out, and a crop of new ones, who didn’t know where the bathroom was, would take over. I don’t care. We can’t do worse than the current lot.
.

Social Security in violent transition?

Jackie Calmes at the NYT has a good summary regarding the last minute effort to get an extension of the 2% payroll tax reduction for 2012. (There is consideration this morning for a two month extension) There are some subtleties of the debate that are worth noting. Both sides agree that an extension should happen, but within both parties there is surprising opposition. The lovers of Social Security see the handwriting on the wall. They fear that a second year of a payroll tax break may be the last step leading to significant changes in America’s biggest social program.

However, that the payroll reduction hurts SS is a common misperception. That's not correct. Every month, the Treasury transfers cash to SS in order to make up for the shortfall. I follow this stuff; if these transfers had not been made, I (and a bunch of others) would have blown the whistle months ago.

As a result of these transfers, SS ends up unharmed by the tax break. Other taxpayers foot the bill.  But since we have a deficit to begin with, this just adds to the countries red ink. Uncle Sam is digging into one pocket and transferring wealth to SS. This is the socialization of Social Security. What does it mean if SS becomes a ward of the state?  Charles Blahous, an ex Bush advisor had this to say:

“The payroll-tax cut would take a major step toward transforming Social Security from what it has long been — an earned benefit, funded by separate worker payroll taxes — into an income-tax based system more akin to welfare.”

For years the SS defenders have pointed out that SS is self-funding and does not contribute to the deficit. That was not true in 2011 (to the tune of $115b). The on-budget expense/increase to public debt will be $120b in 2012. That’s real money.

It's an unfortunate fact that the US economy will flounder if workers pay only 2/3rd of the statutory rate in 2012. That’s how fragile the economy is. It’s not likely that things will be much different a year from now. Another “one time only’ extension of the FICA tax breaks will be on the table twelve months from today. From the Times:

Robert Reischauer, Ex CBO and SSA.
“Imagine that next December the unemployment rate is 8 percent and a year later it’s 7.4 percent. We’ll still be trying to stimulate employment and terminating the payroll tax holiday will be a big hit on most families, one that will hurt job growth.”

Reischauer is right, we will not revert to the statutory rates,  much less the 1% increase that is require to stabilize SSA.  I think he's also correct with his projection of a huge fight:

“The nightmare that I have is that when it comes time to raise the tax back up to 6.2 percent, conservatives are going to propose that these two percentage points of payroll tax be devoted to individual accounts. That will precipitate a huge fight and could change Social Security in a fundamental way.”

There is a huge brawl in front of the country on this issue. Folks on both sides are deeply entrenched. The following is an exchange I saw on Angry Bear blog. It's an example of the rhetoric we will get,  The fellow who wrote this, Dale Coberly, is a fairly well-know contributor to the SS debate. Dale loves SS and hates anyone who thinks that changes are required. If you have any doubts how visceral a fight we're in for, consider this bit of fluff:

rjs

just a heads up...

Bruce Krasting says Social Security 2011 - Another Bad Year...he concludes: The current thinking is that SS is a problem that can be worried about in another ten years or so. That's simply not true.

12/08/2011, 13:00:51

– Reply

coberly
rjs

there are bigger liars than Krasting writing about SS. I can't keep up with them all, and with Obama killing SS outright with the permanent payroll tax holiday, and the Democrats and Progressives rallying behind him, there is nothing more I can do.


Maybe Krasting will be out of a job soon.

The stalwarts of SS recognize that the program is now vulnerable. They want bad things to happen to those who believe changes are essential. We're going to have a fight. A big one. Think, “Age Warfare”.
.

CBO on Tobin Tax - "Don't do it!'

The Congressional Budget Office (CBO) explored the consequences of a Tobin tax, after it was asked to throw in its two cents in regarding proposed legislation, H.R. 3313 / S. 1787. The proposed new law has a very catch title:

“Wall Street Trading and Speculators Tax Act”

Who wouldn't like something like that? For a country that (A) is desperate for revenue and (B) whose populous hates financial fat cats, speculators, monstrously paid bankers, and ridiculously paid hedge fund execs, a transaction tax is an easy sell.

I’ve taken grief on these pages with my position that taxes are a necessity. “Zero” is not the right number. The only questions are who pays and how much. With that said, it’s hard for me to push against a transaction tax. But I’m against this. The costs will outweigh any benefits that are created. I think the CBO agrees. Some bits from the report (Link):

For a transaction involving a stock, bond, or other debt obligation, the tax would be 0.03 percent of the value of the security.

Gee! Only .03%! Hardly worth noticing! Actually it is. Based on recent turnover  the cost of the tax would be $1.7mm every day for those trading AAPL. For GE and BAC, it comes to a rake of $327k and $425k, respectively. That’s real money.

The argument will be put forth that the tax is only a few pennies. A long-term buyer of AAPL would have to pay a total of only 24 cents to buy/hold/sell a share. For BAC, it's only 3/8th of a cent (.0032).

The transaction tax on Government bonds will only be applied to maturities over 100 days and not applicable to any new issuance. So if you were looking to park $100k in T notes for a year, you could avoid the tax by participating in the government’s auctions. That’s stupid. No one will do that. People will call their brokers and it will cost them an extra 30 bucks to own the Note.

The US bond market is very complex. It has nothing to do with retail demand. A substantial portion of the $10T of Treasury plus $7T of Agency paper is in perpetual float. I estimate that at least one third of the outstandings have no permanent home. It sloshes about the globe based on a variety of macro forces. How many times do they  “slosh” in a year? Much more than you might think. The number is a minimum of 5Xs. (I think it is around 7Xs, it could be as high as 10Xs) Using the low estimate, the annual float turnover impacted by the tax equals $25T. That teeny weeny tax would therefore suck $8 billion out of the market. That’s a very big deal. The CBO sees this pretty clearly:

Securities that are traded frequently, such as Treasury securities, would be more affected than securities that are traded less frequently.

The proposed transaction tax would lay waste to the HFT crowd. Their spreads are far too small and their volumes too high, to not have their business models get crushed by a Tobin tax. Many will cheer, myself included. But a sudden death of the algo computers would be very destructive.

The tax would also decrease the volume of transactions and would make some types of trading activity—such as derivatives transactions to manage risk and computer-assisted high-frequency trading—unprofitable.

This is about the money and how much one keeps. So every effort will be made to divert trading activities outside of US tax jurisdictions.

Traders would have incentives to avoid the tax either by trading offshore or by creating new financial instruments that were not subject to the tax.

As the trading activity goes outside of our borders,  so will all those traders and their high paying jobs. Also would go the thousands of back office/ support staff that goes with this.

As foreign holders of U.S. securities moved their transactions abroad, more of the market could go with them, which could diminish the importance of the United States as a major global financial market

All taxes have consequences. A Tobin transaction tax would be no exception:

In the short term, imposing the transaction tax would probably reduce output and employment.

Beyond the first few years the tax’s net impact on the economy is unclear.

Unclear? This is pretty clear:

The transaction tax would raise the costs of financing investments to the extent that it made transactions more expensive, financial markets less liquid, and management of financial risk more costly.

A net change in the amount of investment would in turn affect GDP and employment. In the short term, a decrease in investment would lower demand for goods and services and thus reduce output and employment.

Reduce output and employment? Just what we need.

These consequences are not the ones that worry me. I’m concerned with liquidity. What will happen when 50% of short-term trading is eliminated? The CBO has an answer for that:

The tax might discourage short-term speculation, which can destabilize markets and lead to disruptive events (such as the October 1987 stock market crash and the more recent “flash crash,” when the stock market temporarily plunged on May 6, 2010)

How might the markets welcome a transaction tax? I say this would get a huge thumb’s down. If you believe that wealth in 401Ks drives the economy (I do), then this will bring (another) recession. The CBO agrees, sort of.

Initially, the transaction tax would reduce the value of existing financial assets, because investors would not be willing to pay as much for assets that had become more costly to trade. That reduction would produce an immediate—though probably small—decline in wealth for people who owned financial assets when the policy was enacted.

Note: The CBO are a bunch of bean counters. They have not the slightest idea what the markets may do if this tax was enacted. When they say the consequence to assets values will “probably be small” they are making it up. (A Wall Street broker is not allowed to say things like this. The outcome is not predictable)

This is not a tax on speculators and guys who wear white spats on Wall Street. This will impact all the pension and savings plans:

The transaction tax would also affect the funding of state and local pension plans ($3 trillion as of June 2011). Besides initially reducing the value of their existing assets slightly, the tax would raise transaction costs for pension plans. Both of those effects would increase required contributions to the plans.

Note: There’s that “slightly" thing again. Shame on the CBO for soft peddling the risks.

I wouldn’t be surprised to see that a transaction tax becomes a political football in the next election. Obama will support it. The Republican candidate will oppose it. If the election were tomorrow, Obama would handily beat either Newt the Fool or Mitt the Suit. Unfortunately, I think a transaction tax, and all the bad things it will bring, is in our future.
.

The Fed, MFG and Reg. T

I think there is sufficient evidence today to conclude that Re-Hypothecation is at the root of the customer losses at MFG. This Reuters story started the discussion on re-hypothecation. There have been several additional articles on this at Zero Hedge,  (link, link) and FTAlphaville (link, link).  Let me add one additional bit of info.

The Canadian customers of MFG got their money back within 10 days of the MFG bankruptcy. The accounts that have lost money are either USA or UK based. In Canada, re-hypothecation is not permitted. I got these comments from a Canadian MFG account holder:

The trustee where segregated MF Global Canada customers' funds were held was RBC Dominion Securities. I don't think any of these funds ever left the trustee in Canada. Likelihood is if they left, the Canadian government would have made the parent Royal Bank of Canada eat up the losses and make full restitution.

We shall see in the coming weeks if, in fact, re-hypothecation is the cause of the problems. I’m convinced it is.

The rules on broker's ability to A) Hypothecate and B) Re-hypothecate in the USA are spelled out in Reg T. This set of rules has been established by our good friends at the Federal Reserve Bank. Let me provide some telling words on this re Reg. T rule 15c3-3: (emphasis mine/Link)

• Except as otherwise agreed in writing by the OTC derivatives dealer and the counterparty, the dealer may repledge or otherwise use the collateral in its business;

• In the event of the OTC derivatives dealer's failure, the counterparty will likely be considered an unsecured creditor of the dealer as to that collateral;

• The Securities Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.) does not protect the counterparty.

Well there you have it. Reg. T does permit the broker to “repledge” (AKA re-hypothecate). In the event of default by the broker, the counterparty will be considered an unsecured creditor. (AKA customers lose money). And SIPC provides zero protection to account holders in the event of a broker default.

For me, there is sufficient information to conclude that Reg. T is flawed and must be changed. I have to believe there is any army of lawyers over at the Federal Reserve looking into this as I write and they are struggling with what they can do to “fix” the problem.

For sure a fix is required. MFG has not, as yet, morphed into a systemic problem. But we are getting closer by the day. The Fed is aware of this. The risk is that customers start to withdraw funds and assets from other brokers. The deleveraging this would cause would be catastrophic. A significant chunk of the shadow banking system (about $10 trillion) is dependent on the liquidity that is created by hypothecation. (The situation is bigger and more problematic in the UK)

A month ago Fed governor James Bullard stated on CNBC that the issues with MFG did not constitute a systemic problem. I wrote about this at the time Bullard made those comments. I made a public bet with Bullard (a six pack of beer) that he would be forced to eat his words. I never did hear from him.


I’m re-doubling the bet this AM. If Reg. T is confirmed to be the source of customer losses at MFG then Reg. T will have to be gutted. The changes will have to take place fairly quickly. The consequences across all markets of these changes could prove to be a devastating blow.

The nice folks at the FRB are having a big meeting this week. Reg. T and MFG will almost certainly be on the agenda. I have to believe all those smart folks at the Fed have figured out that we have a problem. We may well get some announcement on this topic by Friday.

Any changes to Reg. T will have profound effects on global markets. Not only the exchanges/asset prices will be affected, this has the potential to derail the global economy. We are already in a very dangerous liquidity situation. If the Fed is forced to change margin rules, liquidity will dry up for an extended period of time. Forced changes in Reg. T will prove to be a Black Swan event.


Note:
Should we get a confirmation of the foregoing discussion and the Fed is forced to react and make regulatory changes, there will be significant long term implications for the Fed. The Fed will have to shoulder the blame for the flaws in Reg. T. They will also have to take responsibility for the broader economic consequences that will surely follow those changes.

The possibility exits for the Fed to lose any credibility they may still have in the US and abroad. The completely unregulated Federal Reserve may lose its independence as a result. There are big downsides to significant revisions to margin rules. The upside is that the Fed’s supreme power over the global economy would be finally checked.

.

The latest gimmick to fund the payroll tax cut - stupidity

We have a week left to resolve the issue of extending the 2% break on Social Security taxes (FICA&SECA). I still think there will be a last minute fix on this; it’s too important. Without this tax break the economy will hit a wall next year. Whatever your thoughts are today about the prospects for a recession in the next 12 months, you’ll have to revise the odds way up if congress fails to get a deal. It’s a measure of just how economically vulnerable we are that 2012 is make-or-break as a consequence of how this plays out.

The latest insanity on this topic comes from the WSJ today.

The deep thinkers in D.C. are trying to offset the cost of the one-year 2% reduction ($115B) in payroll taxes by levying an incremental cost onto Fannie and Freddie and therefore those with mortgages. This is the worst kind of whack-a-mole thinking. There is not an economist worth his salt that does not recognize that housing/mortgage costs are central to any long-term recovery for the economy. The knuckleheads in Washington want to add $38billion a year (for the next decade) onto mortgage borrowing costs. I’m sorry, but they’re idiots for even proposing something dumb like this.

My proposal is simple. Make corporate America pay for this tax break. Raise the FICA tax on large corporations by ½%  (from 6.25% to 6.75%) for the next five years. That’s peanuts ($30B a year). They will never feel it.

My suggestion is that smaller companies be excluded from the incremental tax. Those entities that hire less than 1,000 workers or have revenues less than $25 million would be exempt. This group of companies represents about 20% of all companies. The other 80% would foot the bill. It would, therefore take 5 years to “pay” for the 2012 tax-break for workers.

I’m not in favor of any tax increases or more government spending. But if there has to be a tax break in 2012 I can’t think of better way to raise the revenue than from large corporations. Consider the history of tax revenue in this country.  (Data from Congressional Research Service PDF-Link)

1952 corporate tax as a % of GDP = 32.1%

2010 corporate tax as a % of GDP = 1.3%
(A 95% drop)


1952 Payroll taxes (Social security) as a % of total federal revenue = 9.7%

2010 Payroll taxes (Social security) as a % of total federal revenue = 40.0%
(A 400% increase in the burden on workers)

Our political leaders are so deeply in bed with large corporate America that they have not even considered a very small and temporary corporate tax increase to fill an important bucket. Instead, they want to pass the cost onto those who desire to own a home.

This business about the payroll tax cut is hardly worth noticing in our big economy. But we can’t figure out how to pay for even this small step. The reality is we need a plan to raise about $2 trillion of additional revenues over the next decade. If our leaders can’t suck it up and realize that corporate America has to shoulder its share of the burden on a one-year payroll tax cut, then we don’t stand a chance in hell of coming up with the $2T we need.

.

Another Sweet deal for Buffett – Who pays? You do!

Yesterday, First Solar (FSLR) announced that it had sold its interests in a big solar project called Topaz. The buyer was MidAmerican Energy Holdings, a subsidiary of Berkshire Hathaway. So Warren B. is behind the transaction. I think he got another sweetheart deal. This time, it’s the taxpayers who will be making Buffett richer.

The transaction is between two companies. As a result there has been little disclosure of the actual terms and conditions. The following is my thinking on what is behind the transaction. If I have it wrong, the nice folks from Omaha can send me a note and I’ll publish their response.

There are a number of angles to consider in this story. I’ll outline a few and try to tie them together.

The Topaz solar project is in San Lois Obispo, California. Construction began a month ago, and will not be completed until 2015. The facility is designed to produce 550MW of energy. The cost per MW of these types of facilities is between $3mm and $4mm per MW. Using the mid point of $3.5mm you get an estimated cost of construction of $1.925 billion. Add in another $75mm of soft costs and the total should come to $2 billion.

Bloomberg confirms my estimate on the completion costs of Topaz with this headline.

Buffett has purchased the rights to build a solar farm. The money he is putting up will be the construction costs over the next four years. First Solar will get some consideration as it has absorbed all the front-end costs, but it would be a mistake to assume that FSLR is getting anything close to $2B from Buffet. (Neither of the press releases from the companies mentions cash consideration.)

Buffett’s only condition to the deal is that the Power Purchase Agreement ("PPA") that Topaz has previously entered into is affirmed to Berkshire’s lawyer’s satisfaction. This is a critical part of the deal.

California’s monster electric utility, Pacific Gas & Electric (PGE), has entered into a 25 year PPA with Topaz. With PGE taking all of the power from Topaz, the risks in the deal fall sharply. The output of Topaz has already been successfully monetized. All that needs be done is complete the construction and then let the sun shine.

It’s important to understand that Uncle Warren has a seat at this table because the Department of Energy failed to approve a big loan to Topaz prior to 9/30/2011 (the deadline to get federal subsidies). The DOE did substantial work before nixing the deal. This PDF link to the DOE shows just how much had been accomplished prior to 9/30. (How much did this report cost the DOE/us? Many millions.) All of the necessary approvals and engineering work had been completed. Construction of these solar farms is not all that complicated once the approvals and site work has been signed off on. Buffet got a deal that was teed up and ready to go. Construction commenced a month ago. Warren bought into a deal in the 11th hour. He got a shovel ready investment. He has very little risk at this point.



When Topaz is completed, energy will be produced. Pursuant to the PPA Topaz/Buffet will receive checks monthly from PGE for the next 25 years. That stream of revenue is assured. PGE is a single A. Its long-term debt yields are in the mid 4% range. I’m certain that Buffet got a better yield than that. But the yield is not what brought Buffet into the deal. It was taxes and his desire to avoid them that got this deal inked. Again, that Bloomberg Headline:

It's clear that as part of the deal, Buffett got the tax breaks associated with Topaz. The federal tax subsidies for solar construction belong to Buffett. The numbers are huge.

Once completed, the owners of a solar farm get one of two massive incentive payments:

1) The owner gets a cash grant equal to 30% of the construction cost, or;

2) The owner gets a break on their federal taxes equal to (get this) 100% of the cost of the project. This “Bonus tax deduction” can be used to reduce federal taxes in the year that that the project is first completed.

Berkshire Hathaway paid 29% taxes in 2010. This would imply that it would opt for the cash payment of 30% ($600MM!). But BRK is actually faced with a statutory tax rate of 35%. Therefore the value of the tax reduction could be as high as $700mm. (Warren can engineer any income necessary to max out the tax deduction.)

The PPA with PGE will return all of Buffett’s $2B of investment plus a return of at least 5%. But when you add into the calculation that in four years Buffett gets a mega tax-break the implied returns soar. I did an IRR assuming a 2015 construction completion, $2b cost and a 25-year payback. It comes to a return of 15 -17% pa. This is a terrific return from what is functionally an A risk.

This monster result is exclusively the result of the tax breaks Buffet will enjoy. In other words, “you” are making Warren richer.


Notes:

As I indicated, the PPA with PGE is central to Buffett’s investment. It’s important to understand why PGE has stepped up to facilitate Topaz. California (and 30 other states) have passed laws that mandate that electric utilities MUST produce or acquire a percentage of their electricity from alternative sources. In California. Executive order S-14-08 mandates that 30% of all power sold in California must come from alternative sources by the years 2020. This means that PGE is in a bind. It HAS to have alternative energy or it can’t grow. So PGE came into the Topaz deal desperate for a supply of power that did not come from fossil fuels. Topaz solved (in part) PGE’s problems.

There is one technical aspect to the Buffet/Topaz deal that I don’t quite understand. The rules on the tax breaks/rebate are very clear. Not less than 5% of construction must have been completed by 9/30/2011 in order to qualify for the subsidies. As I have indicated construction of Topaz did not commence until November. It would appear that the requirements for the subsidies has not been met. The possibility exists that the DOE agreed to allow for the subsidy and waived the 9/30 deadline. Another possibility is that the DOE gave credit toward the 5% completion by allowing for the pre-construction soft costs of the project. If it is the latter, I’m confused. Other projects that I’m aware of did not get credit for pre-construction soft costs. One additional possibility is a waiver of the completion requirements was granted, AKA "Side Deal".

When the DOE money did not come through, it must have been a big blow to the White House. Topaz was a big prize for them. I wonder if Obama called his pal Buffett and asked for a "fix". Warren B. delivered. But, as usual, he charged a pound of flesh. Obama got what he wanted. He avoided another solar disaster when WB stepped in.

Summary:

-Buffett gets another sweetheart deal that makes him richer.

-PGE gets a long-term supply of alternative energy that allows them to grow for a few more decades.

-First Solar gets out of a huge headache. It gets get to sell solar panels to Topaz.

-The citizens of California that will use this power will get nothing. They will continue to pay the highest rates for electricity in the country.

-The US tax payers foot the bill for another $600 - $700mm. That's the "Vig" for Warren. Those taxpayers also get nothing in return.
.

On Corzine - MFG in the fog of war

I watched Jon boy. I didn’t hear any smoking guns. That doesn’t mean there weren't any. Keep in mind that Corzine has the best lawyer (for this) that money can buy. Andrew Levander has been advising the former CEO of MFG on every word he says.

I was surprised that there was no 5th Amendment stuff. I’m sure that Levander was pushing for that. But Corzine really didn't have much of an option. If the former Senator/ Governor pled the fifth he would have been convicted in the public’s eye.

So Jon talked, but he said nothing. You can be absolutely certain that Corzine spent many hours with his lawyers fielding question that might have been asked by the congressional committee. When Corzine seemed to stutter, pause, look up at the ceiling groping for the right words to use, it was just a very well orchestrated and practiced acting job.

Jon made one response that I thought was significant. He said several times:

"I never intended to break any rules.”

This could mean anything, but consider that this canned response was formulated word for word by Levander. I think what Corzine was saying was that he may have authorized some actions in the later stages of MFG’s existence that ultimately led to the expropriation and loss of customer funds. He is trying to establish that whatever he may have said (or signed), he did not understand the consequences. Whether this is true or not, I don't know. We might find out at some point that some clown in the treasury department at MFG asked JC a question in the middle of the panic:

“We could re-hypothecate the seg accounts and plug the gap tonight! Should we do that?”

And Jon could have looked up and said:

“Do what you can!”

The problem with the “I never intended” defense is that it doesn’t work for a CEO who should have know better.

**************************************

I recently had a conversation with an individual (we'll call him Bob) who had three MFG accounts. He, like many other customers, smelled a rat with MFG as the stock price plunged and the FINRA issues with the Euro bond positions became known.

Bob voted with his feet. He closed off all open positions. He got back to cash. Then he requested a wire transfer for the balance(s). He left a small operating balance in the accounts in order to keep them open. This fellow was small potatoes. Two of the accounts were under $20k. The other was $215k. Wire transfers to a bank were requested.

According to Bob, the wires went out on Wednesday, October 26 (four days before BK). All three wire transfers were received on Thursday October 27.

But on Friday, October 28, the bank that had received the funds reversed the wire transfer for the larger amount. The transfers for the two smaller amounts were not reversed.

This is highly unusual. It is extremely difficult to reverse a wire transfer. Wire transfers are considered to be Immediately Available Funds or “Good Funds”. Absent a court order, the only way to reverse a wire transfer is when the remitting bank provides a letter of indemnity ("LOI") to the receiving bank. I’ve written these letters. They would look something like this:

To: ABC Bank
From: XYZ Bank
Reference: Wire Transfer #123456 date 10/26/2011 for $215,000 for further credit to "Customer Name", Account #AB3355


We hereby request that you immediately debt the account of (Customer Name) for the full amount of the transfer and return the funds to us.


If you comply with this request we hereby agree to hold you free and harmless of any consequences that may arise as a result of this request.


XYZ Bank

Basically XYZ has to give ABC a blanket guarantee that they will not get hurt by the request.

Here’s the rub. I’m told that in the matter at hand, the "XYZ" bank operating on behalf of MFG was JPM.

If I’m right that a LOI was required to claw back a wire transfer, then - assuming my information is correct, and I think it is - it had to have been JPM that wrote the indemnity letter.  (No one would have acted on a LOI from MFG on 10/28).

I'm speculating quite a bit. But it’s still worth considering. At this point, anything is worth considering. We are six weeks past the BK. As Corzine and all the others said today, they have no clue where the missing money is. There has been any army of forensic accountants (FBI & KPMG) toiling night and day. No one has found the money. That's crazy to me.


A possible daisy chain:

(1) MFG orders XYZ Bank to make a money transfer.

(2) XYZ makes the transfer.

(3) After the transfer has been made (or during the same day) XYZ issues a letter of indemnity (“LOI”) and obtains a refund of the transfer.

(4) The initial wire transfer is accounted for (correctly) at MFG as a reduction of the customer account liabilities (Segregated account).

(5) When the money comes back into XYZ (pursuant to the LOI) it is not credited back to the Seg./customer account. (The fog of war factor? Deliberate?)

(6) After the money has been returned to XYZ bank, it appears to be "unrestricted funds" of MFG. It gets commingled. Someone grabs the money to offset a claim. The Chinese Wall between the Seg. account and MFG corporate account has been broached. Once the money is commingled, it is impossible to figure out who owes what to whom.

A question for any of those many MFG account holders: Did any of you have a similar experience with wire transfers? If so, could you let me know? I’d love to get to the bottom of this mystery.
Bkrasting@gmail.com

Note: I'm aware that in the final days, MFG issued checks to customers that bounced. This is similar to the wire transfer issue I describe. But it is also a different kettle of legal fish. There are many reasons for a check to bounce. Checks, unlike wire transfers are not "good funds".  To claw-back a wire transfer requires significant human intervention. Banks do not write LOIs without carefully considering the consequences. There's always a signature on an LOI......
.

On Boeing - Where's the money?

There was a period of time when I got stuck working on deal-teams that were trying to finance airlines. In corporate finance you usually work on a deal until it happens and then you move onto something different. Not the case with airline finance. These dogs always need more money. No one wanted to work on the deals (they were always shitty and very hard sells). The list of my "AAA" clients included: Eastern Airlines, TWA, and Continental Airlines. Two of my clients ceased to exist; Continental went BK again and again.

This was in the 80’s when finance was not as sophisticated as it is today. But I tried to be creative. We hocked everything we could get a UCC filing on. Spare tires and parts (even used tools), engines so old they could not be used, landing rights and other things that had no real value. One of my highlights was when I financed the gangways that connected the planes to the gate.

Years later I got smashed in the head again when I got involved with a (very) failed effort to LBO United Airlines.

So add me to the long list of folks who have sworn off ever putting up a dime for the airlines. It’s one of the surest ways to lose money. My advice to anyone thinking of putting money to work in airlines is that before you write a check, hold your breath for three minutes. As (virtually) no one can do this, then no one would lose money in this cesspool. My investment rule works perfectly.

With that as an intro I take you to this article in the FT today:

The title says it all. No one should be surprised that the EU banks have turned off the spigot. They are all trying to broadly deleverage. They are already full up on dodgy aircraft paper. What I want to add is that the EU banks have been major providers of liquidity to the global air carriers for decades. The reason that I got involved with this mess was that I knew many European banks. They were all in love with high yielding asset backed lending. Airlines and the EU banks were a perfect match. That these banks are now out of the picture is a very big deal indeed.

A Boeing VP, Randy Tinseth, had this to say recently about those EU banks: (Bloomberg Link)

“There’s been a lot of concern in the market about the availability of capital, especially the situation with European banks.”

So what’s Boeing going to about the shortage of debt capital for the air carriers? Simple. They are going to take the paper right back on their books. From Commercial Chief Executive Officer, Jim Albaugh:

“Our strategy will be that Boeing capital will be much more than a lessor of last resort.”

Oh boy! Look out! Boeing is going to be financing its own sales. (Just like GE does.) I looked at the Boeing Capital home page. This is a list of financial products the nice guys at BA are offering:

The first two categories are the safest of the lot. All the other stuff is very high risk lending. The last on the list, Subordinated Debt, has proven to be a guaranteed way to lose money.

It’s not that leasing (finance or operating) are without risks in this industry. The article that I quoted from is from November 13th, not a month ago. In that article the same Boeing Execs were crowing about their big success in leasing:

Boeing’s strategy to use its capital arm as a tool to gain an edge on strategic competitions was highlighted in July by an agreement with AMR Corp.’s American Airlines, where Boeing committed to providing 100 single-aisle jets to the airline on lease.

Well, 17 days later their best customer did a flame out:

Possibly Boeing Finance will end up doing better at this than I did. I doubt it. If they have any questions on where this strategy leads, they should ask Carl Icahn. He’s been bruised as much as anyone.

BA’s stock is at 14Xs earnings today, not so cheap at all. Possibly investors considering a punt on BA should hold their breath for 3 minutes. That 2.3% dividend everyone likes so much is not nearly enough to cover the risk.

.

Social Security 2011 – Another Bad Year

Note: After writing this article I received a number of comments that questioned whether the numbers presented in this piece reflect the 2% payroll tax holiday that occurred in 2011. The answer is that these numbers do take that into consideration. Yes, there was a tax break this year. But there was no consequence to SS as a result of the tax break. Every month Treasury has transferred money to SS to make up for the shortfall. The American people are $110B poorer, but SS is not.

The following is a slide from SSA that shows income components on a monthly basis for 24 months (ending 10/11). Look on the bottom right and you will see a new revenue source as of 1/1/2011 marked Other Income. This is the monthly transfer from Treasury to make up the drop in actual tax receipts.

Sorry If that was not clear.

The original article:



Full calendar year 2011 numbers are now available to calculate the results for the Social Security Trust Fund. Here's a look at the key numbers that will be reported to Congress in four months:

Payroll Tax Revenue: $669B ($642B - 2010)
Benefit payments: $726B ($702B -  2010)

Primary Deficit: $57B ($60B -  2010)

Other cash components at SSA:

Tax on benefits:  $23B (2010 - $24b)
Payments to R.R. Retirement: $4.6B ($4.4B - 2010)
Overhead: $7.0B  ($6.5B - 2010)


Net 2011 cash drain: $46B  ($49B - 2010)

Non cash items

Interest: $116B ($117.5B - 2010)

Paper surplus: $70.0B  ($68.5B - 2010)

The reported numbers will show a very small improvement ($3B ) in the net cash drain. This may cause some to look at the 2011 results and say, “See! Things are stabilizing and even getting better!” Let me try to blunt any enthusiasm in advance.

SSA measures (A) actual monthly cash receipts and then (B) makes assumptions about what additional amounts are coming in based on a series of macro assumptions (GDP, employment/unemployment, etc.). The Treasury Department pays SSA the sum of A+B. Ultimately all of the money is accounted for and any adjustments (plus or minus) are reflected in the next year's results.

This system works pretty well as the annual adjustments have been fairly modest and the adjustments have been both positive and negative. That was not the case in 2009. The models that SSA uses significantly overestimated tax revenues in that year. As a result, there were very significant downward revisions to the actual receipts that were reported in 2009. Following is a slide of SSA’s monthly 2010 revenues. Note that the revisions to FICA and SECA from the prior years totaled $28B. (2009 and 2011 also have significant prior year adjustments.)

To regularize the data for the big accounting changes it is necessary to add/subtract the adjustment from the prior year and then look forward to what overstatements/understatements were made in the then current year. When the ins and outs are made, the results for the regularized FICA/SECA revenue numbers are as follows:

2005....$521B

2006....$553B

2007....$585B

2008....$615B

2009....$676B

2010....$702B

2011....$726B

The following chart shows adjusted Payroll Tax revenues minus Benefit Payments:

Looking at the data on this basis, you'll see the actual deterioration that took place in 2011. 2012 will be worse than 2011. Benefits are going to jump by $50B+ next year. 10,000 new people are signing up for checks every day of the week. Add the fact that every one of the 55mm beneficiaries will be getting 3.6% more in their checks (COLA adjustment). The revenue side is a wild card. What will GDP be? If it's around the 2% that is currently anticipated, revenues at SSA will fall well below plan. A flat economy (+2%) would translate into a $100B 2012 primary deficit (payroll receipts minus benefits). A number like that is not on anyone’s radar today.

The following is a chart used by the House Finance Committee. It plots the expectations for net cash drains at SSA. While there is plenty of red ink in the chart, there is not nearly enough to describe what is going to happen. Note that the expectation is for some improvement in 2011 and relative stability until 2018 when the red ink explodes. On the chart, I think today we are really at the 2017 level. 2012 will bring us the results depicted in the chart for 2018.

The 2011 numbers for SSA indicate that we are at least five years ahead of existing thinking on the SSA deficits. When this realization sinks in, it will break the hearts of the SS defenders. If we are, as I contend, five to six years ahead of “schedule” with cash deficits at SSA, there is no alternative besides cutting scheduled benefits. Raising taxes to fill a hole this big is not an option. Nor is it an option to maintain the status quo and allow for a very rapid rundown of the SS Trust Fund.

If we are going to experience what I believe we will, then the cumulative SS cash shortfall over the next decade will add ANOTHER $1.5 trillion onto Public Sector Borrowing ("PSB"). (A shift from the Intergovernmental account into the PSB account; AKA the Chinese). This increase in PSB more than offsets the $1.2 T of cuts that the congressional super committee failure has just mandated.

The consequences of SS (and similarly the other government retirement funds) on PSB over the coming years is not now being considered by those looking at America’s debt profile. It will be soon enough. The current thinking is that SS is a problem that can be worried about in another ten years or so. That's simply not true.
.