Bernanke - 'The Fed never makes mistakes'

Everyone makes mistakes. The best thing one can do is face up to the facts and acknowledge the error; fix the problem to the extent possible and do what is necessary to avoid repeating the mistake. Ben Bernanke's inability to admit his (and his predecessor's) mistakes condemns the Fed to repeat the sins of the past.

In this week's lecture tour at George Washington U, Bernanke spoke to the students about the causes of the economic collapse of 2008. In his presentation, he identified most of the bad actors and the mistakes that those institutions made. He pointed his finger at:

-Fannie Mae and Freddie Mac
-The big banks and Wall Street wire houses
-Mortgage brokers
-AIG

He blamed:

-Sub Prime mortgages
-Excessive leverage
-Banks’ failure to adequately monitor and manage risks
-Excessive reliance on short‐term funding
-Increased use of exotic financial instruments that concentrated risk

Bernanke never acknowledged that the Fed contributed to the mess of 2008. If Ben wasn't flat out  lying, his head is buried very deeply in the sand.

In response to the recession of 2001 the Fed allowed money supply to increase by 30% in 4 years:

The Fed also manipulated interest rates. It drove short-tem rates (Federal Funds) to 1% in 2004.

When Greenspan tried to normalize interest rates in 2005 he was forced to raise the Fed Funds rate 13 times. This sharp increase was a significant factor in blowing the top off of the real estate market. Greenspan’s Fed contributed to the housing bubble. The Fed's tightening brought on the bust that it helped create.

So where are we today on the critical issues that brought about the collapse of 2008?

Money supply is zooming:

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Inflation is chugging along:

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Interest rates are pegged at zero:

The Fed’s balance sheet is bloated

The government is still making junk mortgages; FHFA is guaranteeing loans at 97.5% of value.

Consumers are borrowing more. Debt has grown 6% in the past year, three times the rate of growth in the economy.

Student loan balances have been exploding. They passed the Trillion mark this week:

The savings rate is the lowest it’s been since the crisis. Who would want to save money when the return on savings is negative?

Junk bonds (and other forms of exotic debt) are back in style, and investors are lapping up the swill up.

Funny money credit is back. This outfit is lending money to all comers. I love it when the lady says, “Yes it is expensive”.  (11 second video)

It’s not just expensive money, It’s crazy. Consider this chart of pricing:

If you want $10,000, the cost will be $52,343 in interest. If you only need a quick $500, these nice folks will give to you, but the cost will be $1800 or 340%%.


For the Chairman of the Fed to stand before all those GWU students and avoid accepting a share of the responsibility for what happened in 2008 is a gross re-write of history. That he does not see that he is making the same mistakes that the Fed made in every prior economic cycle is sad. The audience should have booed him. I am.

Pests

Ben B's speech got a big cheer from the stock market. I think Obama was cheering too.

Two views:

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Other Pests

If you live in America, you know it has been unusually hot. During the week of March 18, 3,550 heat records were set.

The spring heat has brought us a large new crop of unwanted visitors. High on the list is the Halyomorpha halys, better know as Brown Marmorated Stink Bug, or “stinkers” for short. If you have not yet come across these pests, you probably soon will. They are spreading across the country like wildfire.
 

These bugs are hardy sons of bitches. They are about ¾ of inch long, and have a very hard shell. They hibernate in the winter. As a result of the early spring, they are coming out in droves. A few pics of what to look for:

I happened to be in Florida over the weekend and was very surprised to learn that stinkers are problem there. I thought they were just an issue for the North-East. The Florida agriculture Department had this to say about the arrival of Stinkers in the Sun Shine state:

US distribution of this pest is a moving target. These bugs are suited ideally to hitchhiking with items moved by human activity.

In Florida, a specimen was caught in a trap next to a commercial ship berth at Port Everglades. Additionally, several specimens have been found in homes and vehicles of seasonal residents, or residents who moved to Florida from various infested states.

It feeds on a wide range of hosts, including peach, apple, pear, fig, mulberry, grape, raspberry, citrus and persimmon, as well as on row crops such as snap bean and soybean.

Stinkers are a new phenomenon in America. They came to this country from China. They were first observed in 1998 in Allentown PA. They have been proliferating and spreading ever since. They kill crops and are a nuisance. These bugs have the potential to cause a great deal of damage. They have a needle-like nose that bores into fruit/corn and other crops. This ruins the crops.

Last year some poor bastard in Maryland had his house taken over by tens of thousands of stinkers. The bugs won, the homeowner lost:

If you see one of these bugs, don’t step on it. You’ll regret it if you do. When crushed, they stink. Your house will smell awful and you’ll need a new pair of shoes (hence the name). Pesticides will kill them, but that is not a good solution either. If they die in the walls,  they'll rot and stink as if they were crushed. The odor of their death can bring another problem. The smell of the dead stinkers attracts carpet beetles, which can be as problematic as the stinkers themselves.

So far stinkers have been found in thirty-seven states. They hitch a ride on cars and trucks; by the end of 2012 they will be in every state.
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Bernanke: "I Want to Bring Back Irrational Exuberance"

On January 25th we got word from the Fed that ZIRP would be extended until at least 2014. Bernanke's guarantee of another two years of cheap-cheap money has lifted the market's animal spirits. Since the Fed announcement (33 trading days), the S&P got a 7% lift. But that's not the measure of Ben’s success. I’m seeing it in deal flow:

*There have been 29 IPO's that raised $3.3B

*Another 35 deals got inked for secondary issuance of common, preferred and/or convertible stock totaling $3.7B

*The visible calendar for both IPOs and secondaries is big. $4.3B is registered for sale; another boatload of paper wants to get sold on top of that.

*The High Yield market blew out $70B of paper.

*Leveraged loan activity has totaled $75B.

I want to focus on six deals (of the 22 that got completed) from last week that I find troubling. These are referred to as Dividend Deals. The borrower takes on new debt in order to pay a stock dividend to common shareholders. (I prefer to see dividends paid from cash flow from operations, not new debt.)

#1

Borrower: 

SeaWorld Parks & Entertainment

Amount: 

$500 million

Bank syndicate: 

Bank of America Merrill Lynch, Barclays Capital, 

Deutsche Bank, Goldman Sachs, J.P. Morgan, and Macquarie

Use of Proceeds: 

To fund a $500 million dividend to Blackstone Group.

#2

Borrower: 

Armstrong World Industries

Amount: 

$250 million

Bank syndicate: 

Bank of America Merrill Lynch, J.P. Morgan, and

Barclays Capital

Use of Proceeds: 

To fund common share dividend.

#3

Borrower: 

Getty Images

Amount: 

$275 Million

Lead Manager: 

Bank of America Merrill Lynch

Use of Proceeds: 

To fund a common share dividend.

#4

Borrower:  

Telesat Canada

Amount: 

$2.55 Billion

Bank syndicate: 

J.P. Morgan, Credit Suisse, Morgan Stanley, and UBS

Use of Proceeds: 

$705 million will fund a dividend to common 

shareholders including: Loral Space, Canadian Pension Board 

and option holders of common shares.

#5

Borrower: 

 4L Holdings

Amount: 

$300 million

Lead Bank: 

J.P. Morgan

Use of Proceeds: 

Refinance of existing debt and to pay common share dividend.

#6

Borrower: 

Grede Holdings

Amount: 

$250 million

Syndicate: 

GE Capital, Jefferies

Use of Proceeds: 

To fund a $216 million dividend and general purposes.

Note:
Grede Holdings was bought by Wayzata Investment Partners LLC in February of 2011. GE capital provided a portion of the financing. The 2012 Grede deal arranged by GE will result in GE receiving dividend income. This is lining up at the trough for these financial players.

On balance, I think that Bernanke is delighted with these results. He wants the Fed's cheap money to fund this type of financial activity. When debt is used to pay dividends, it creates equity from debt. When the likes of GE and Wayzata have more (paper) equity, they can borrow more, and do more deals. Ben loves it when financial players do deals. He believes that creating financial wealth for GE ends up creating jobs. But there is also a cost:

 

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Another credit bubble is forming. Credit quality is deteriorating, while financial engineering is back in vogue. The Fed keeps making the same mistake of fueling these bubbles. It is celebrating this process as a “success” while at the same time it is sowing the seeds for another bust. Does the Fed really think American’s are better off if Blackstone receives another $500 million dividend?

The problem is, that is exactly what it believes.
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HT:sc

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On Slime and Water

Slimy

Just saying the words, “Pink Slime” gives me the creeps. I’m not pleased to learn that I’ve been dining on this swill for the past sixty years. The US Department of Agriculture has made an interesting response to the public outcry about slime. (Link)  Starting in September, every school district in the country will have the right to chose whether to buy burgers with or without slime.

Think where this goes. Beverly Hills schools will have no slime, while East LA is all slime. Scottsdale will go slime free, while Phoenix has slime-fattened burgers. Westchester will definitely go "No Slime", but I'm guessing the schools in the Bronx will opt for slime. Same for Bethesda versus the District of Colombia. Should we see this new form of “red lining”, income disparity will be a topic of discussion. When school rolls around again, it will be at the height of the election. It will be interesting to see how the candidates handle slime.

The FDA left it up to restaurants and grocery stores to deal with slime as they wish. Without any rules, the public will decide what they want in their burgers.

Some tony restaurants have already changed their menus to assure their customers they are not eating slime. (If the menu has be changed, does that mean they were dishing up slime before?) It’s just a matter of time until more eateries follow suit. This has some interesting implications.

A fellow walks into McDees:

Can I have a quarter-pounder with cheese, fries and a coke?

Yes sir! How would you like that burger? With, or without slime?

It’s funny how a word can make a difference. I’m a big burger guy, so I went and bought a meat grinder and some chuck from the butcher. Delicious, made all the better knowing it wasn’t slimy. Very "Old School".
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Peak Water

Twenty thousand folks from all over the world showed up at the World Water Forum in Marseilles, France this week. For those who lose sleep at night worrying about peak oil, I suggest they re-direct their stress to Peak Water. Peak oil may scare us to death, but peak water will be what kills us.

In less than forty years, two out of three people will be living in areas described as being in Severe Water Stress.

There are two ways of looking at consumption of water on a global basis. The first is per capita: (Total per capita use = Agricultural +  Industrial +  Municipal + Individual consumption / Population

The USA is the world’s water glutton based on this measure of consumption, due to our industrial water use. GDP is directly correlated to total water consumption.

A second way to look at water consumption is by comparing total gallons used.

By this matrix, China and India are the truly big users. Now look at geographic areas that are “water troubled.” China and India jump out as problems. (Mexico too?) Most of India and substantial portions of China are already stressed:

 

 With a population of 1.2 billion, India is already facing a water crisis in some areas.

The US is in a very favorable position when it comes to water. There is adequate rainfall in most areas; the Great Lakes hold 22% of all fresh water. If water is to be the difference in history, then the USA will probably be the last country drinking. Unless we screw it up….
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Is the Ten-Year going to 3%?

These two articles point in a bad direction:

China’s 2011 total trade surplus was $183B. The surplus with the USA was $270B; the US was 150% of China’s total surplus. China imports lots of “stuff.”  Crude oil is high on that list. Increased domestic consumption, plus additional imports for strategic storage, have pushed up imports to 6 million barrels per day in February. At that rate, the 2012 import bill for crude will be $250B, approximately equal to the US trade deficit with China.

The US/China trade deficit is creating USD surpluses for China’s largest crude suppliers, Saudi Arabia. Angola and Iran are the largest providers. These countries are not America’s friends, and they already have too many dollars. When Americans shop at Wal-Mart, they are actually sending dollars to Iran. In 2012, it will come to about $25B of “our” money that ends up with the Ayatollahs. Welcome to the global village.

As a result of the shrinking trade surplus and the need to import expensive crude, China does not have the investable dollars it once had. So it is no longer buying US Treasuries at the previous fast pace. At the same time, the US Treasury is issuing debt at the rate of $100B a month. If the Chinese aren’t buying debt, then it must be sold to other dollar holders.

Saudi Arabia may end up with more dollars in reserves as a result, but I don’t think it will buy long-term bonds with this money. The money will stay in short-term securities. The Saudis will look at the 0.5% they can get on their money for 3-years (or the 5-year at 1%) and just say “no”.

Let's return to the Bloomberg story and the seven-fold increase in bank holdings of Treasury paper:

Commercial lenders purchased $78.2 billion of Treasuries and securities of agencies in January and February, compared with $62.6 billion in all of 2011, bringing their holdings to $1.78 trillion, Fed data show.

It is a financial “unnatural act” when an A- rated bank can extend credit to a AA+ borrower and still make money in the process. This reverse credit arbitrage is made possible by the banks willingness to "borrow short and lend long". The banks are doing it today because they have unlimited quantities of liquidity available to them through the repo markets at near zero cost. They are playing the carry trade. In the process, they are loading up their balance sheets with low yielding assets, and they are taking risks of rising rates. There is a limit to this.

As of this morning, many of those US financials that own the $1.8T of bonds are not so happy. The strong stock market, better economy and rising inflation expectations have clobbered the bonds the past few days. Some may think that the ten-year at 2.20% is a “buy”. But all I see in this chart is the “air” under the current price.

Not surprisingly, inflation expectations have picked up:

 

The easy answer to this conundrum is that the Fed will just keep buying more bonds to keep rates artificially low. I say it can’t do that. If the Fed announced tomorrow that it was going to “TWIST” the market to keep the ten-year at 2%,  crude would rise $150 in a month. Bernanke understands that.

Absent a new move by the Fed to contain long-term interest rates, the ten-year looks like it is headed to 3%. The Chinese are not buying, the banks are full up with paper (and underwater), PIMCO et al are long duration up the wazoo, and any thought that retail interest in five-year bonds at 1% will save the day is just misguided (dumb money is not that dumb).

Bernanke must be delighted today. His strategy all along has been to inflate the S&P and let rising asset values stimulate economic growth. His unlimited supply of cheap money has worked. But it has stoked inflation and that is now being transmitted to the bond market.

I think something has to give, either stocks back off and the economy cools, or the ten-year is headed to 3%. Bernanke can’t have it both ways. He’s about to learn that lesson.

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On Sweet Deals and No Deals

I’m sure that everyone will be glad that executive compensation at Fannie and Freddie (F/F) has been cut. These are public companies that exist at the whim of the taxpayers. As such, the compensation for the folks pulling the levers at F/F should conform to salaries that the president gets, right?

Well, not quite right. The President makes a cool $400 grand. Congressmen get $175K. The 2012 compensation for the senior executives at F/F tops these numbers by a wide margin:

The F/F top brass get nice cushy salaries plus incentive compensation (annual bonuses). Given that F/F are losing money hand over fist, you would think that some of that incentive comp might not get paid. Most of it is. In 2011, 82% of incentive comp was paid.

A large portion of total compensation is paid in the form of a retention bonuses. If the top folks stay in their jobs, they get paid this amount. If they quit before their contracts are up, they still get paid most of their retention bonus. There is a formula that sets the payout that discounts the contractual amount by 2% per month for each month prior to January 2014.

Not surprisingly, both Charles Halderman Jr. and Michael Williams, the CEOs at F/F, have both announced their resignations. As a consequence, they will only be getting 60% of the combined $5.8 million of their deferred comp. amounts. Basically, they will each be getting $1.8mm for not working. A very sweet deal indeed.

Note: The 2012 total compensation package for the CEO's at F/F is down 74% from what it was before the SHTF in 2008. So I guess we should be happy that we are paying folks to lose money at only one-quarter of the rate we once were.

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No Deals

As of noon on Monday the NYSE is headed for the lowest daily volume of the year. The Vix is falling with the low turnover. It’s pushing the levels last we saw in May – August of last year. (See Zero Hedge for details Link)

I can’t imagine a worse status quo. We have complacent markets. Turnover and liquidity are drying up. The market's ability to absorb a shock of any kind is weak.

There is going to be a shock; there always is. The vulnerable stock market is due for a correction. I’m just wondering what the shock will be that brings it on.

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