Monday, December 31, 2007

The Start of the New Year

It’s hard to imagine the coming year. It’s kind of like trying to light a gas stove for five minutes with wet matches and then find a dry one. It could be illuminating.

Republicans and the Democrats are blaming everything that’s wrong in the country on each other. The idea that there can be two ways to get to the same destination seems to elude the politicians and most of the voters. "Right" and "wrong," are concepts that are interpreted differently, depending on the person’s situation. Very few wars are “right,” but there have been a few that I would deem as having been “necessary.” To a Marine in Iraq, “necessary” is also an arguable term.

The new push for health care seems, to be the last straw for the camel’s back. We can’t pay for it now; legislation won’t make it any cheaper. If you ever need to visit the emergency room for treatment and have a credit card, go to Urgent Care (there is no 8 hour wait). The 35 and under crowd would just love a health insurance program; you get taxed for getting old while you’re still young enough to pay for it.

Tomorrow the minimum wage goes up 50 cents and a restaurant with 20 employees has an extra $50k per year in costs. Congress meant well, god bless ‘em, one less employee is not quite what they had in mind.

Real estate is beginning its great decline. Remember that bank foreclosures count as a house sale when you view real estate statistics. This distorts the number of actual buyers. As prices drop, more people will become upside down in their loans. Those that bought into the market in the last five years with ten percent or less down, have real issues (we’re not talking magazine subscriptions).

Unemployment in the coming year could be quite low. Los Angeles is reporting another year of decreasing crime. It more or less suggests a significant drop in adults in the 17-30 age group, not more effective crime prevention. The labor pool is contracting; add to that, the baby boomers reaching retirement. This could force wages up.

Food costs are increasing drastically. A dozen eggs have gone from 99 cents to $1.50 in the last two months with a sign in the window “limit two dozen.” Granted, eggs have been $2.69 a dozen at Ralph’s for years, I just don’t buy my eggs there. The damn chickens got a pay raise and I didn’t!

The big difference between a blog and the news is; we are suggesting what may happen in the future, whereas the Newspapers and TV report what has happened. We are looking forward and they are examining the past. The news media needs, “Who, What, Why, When and Where,” for a story. Without it, it ain’t news. A blog is kind of like little Johnny telling Daddy that Mommy’s been fooling around. Daddy needs a name before he loads the hand gun. When he pulls the trigger you have all 5 W’s. Now that's news!

The good thing about all of this for next year is that this is only a blog. So, "No News is Good News!"

Have a Happy New Year Everyone!

Tuesday, December 25, 2007

The Social Security Medicare Headache

Current financial news suggests the economy is deteriorating. Many institutions are in damage control mode. If an entity is facing an impending bankruptcy, why announce it early? Collect a few more paychecks. People tend to hide problems. Sweep this under the rug and maybe it will go away. The real picture of our predicament is probably still well hidden. Nothing is a clear as it seems. No set of facts describes the whole story. And when you mix and match news reports, there is room for the error of interpretation

People talk about helicopter Ben throwing money out everywhere. It makes a great newspaper story, but it’s way out in left field. All he can do is make the money easier to borrow. The damn problem is you can’t force people to borrow money. If you want to blame Ben for what Congress has spent, be my guest. He is being groomed to take the fall.

Congress is the main player in this game as it unfolds. To get elected they promised the moon and pretty much delivered. This group repealed laws written in the 1930’s that could have kept a lot of this from happening a second time. The country is headed into a deflationary recession but our elected “Cesspool of Irresponsibility” could change all of that. Congress assumed (with good reason) that the tax receipts would increase each year. Even with inflation, they will probably drop next year. Fixed Costs are the real headache. The amount spent on social programs is pretty much set in stone (it isn’t going to get smaller) 56% (See diagram). As tax revenues decrease, the pie gets smaller; the share devoted to social programs increases. A 20 percent decrease in revenues would make the fixed cost rise to 70 percent of the budget.

Congress will have some very unpleasant decisions to face\avoid (choose one) in the near future. Don’t expect them to cut Social Security or Medicare; they want to get re elected. Congress is held accountable for fixing present problems, but responsibility for the future problems doesn’t even enter the equation. From there it is quite simple; the Treasury writes the checks to cover the fixed costs. This is where the money is printed. It’s kind of like a Visa card with no limit on it.

Where will Congress cut when things get worse? There is no answer to that question yet. When FDR was elected, there were no social programs, and by 1948, these programs consumed 10% of the budget. Now where are we? Entitlements are where the cuts will have to be made. To a Congressman, that’s an incredibly stupid suggestion especially come election time.

We are looking at several things in decline; credit, housing, banking and a shrinking tax base. Just think, you got all this, in time for Christmas!

Merry Christmas everyone.

Sunday, December 23, 2007

A Bank that couldn't say No

Let’s take Citigroup and look at their balance sheet. Two trillion in assets, these are customer deposits. The bank has about 127 billion worth of equity (book value $25.479 times the number of shares 4.98 Billion). Don’t confuse this with “market cap” which is the number of shares times the current stock price (152.92 Billion). Market cap could go to a dollar and it would not affect the book value of the company. As a stockholder you could end up with zip. If you hold preferred stock, you are ahead of widows and orphans. Abu Dhabi has preferred stock.

In order to pay a reasonable interest rate, the money has to be invested in some vehicle that has a decent return. It’s a good assumption the bank didn’t invest the 1.9 trillion in Treasury bills or other government bonds; the return is just not there. In three months time, Citigroup has come up with a write-down of bad investments with a total somewhere between 72 billion to 100 billion dollars (see Deutsche Bank spread sheet).These are real estate SIV’s and CDO’s. What happens if we move out another four months? Citigroup’s fiscal year ends in December. How liquid are their assets? The answer to that question is a little like taking a laxative to cure diarrhea. If you think it’s bad now, wait a while.

---Courtesy Deutsche Bank November 11, 2007. Double click for larger image

What did Citigroup invest the rest in? If it wasn’t “invested” in real estate, then where did they put it? Credit card loans or how about hedge funds, both are "real money makers." What ever it is, it is probably not easily convertible to cash.

Can a bank have 100 billion in losses and still be functional? There hasn’t been a peep from Federal regulators. It seems a little like the Donald Trump wing ding of several years back. If the banks had foreclosed on him they would have gotten very little. Instead they loaned him more money and rewrote his loans.

Are the Federal Bank examiners checking the books? They had a rough time with the 125 billion dollar Savings and Loan bailout of the 1990’s. Citigroup is BIG and we are only talking one bank. A bank in trouble is like spotting one cockroach, you know there has to be more.

The amount of money involved in losses is staggering. The amount of money this one bank controls is beyond comprehension. Am I the only one that thinks this needs to be examined more closely? Have I mistakenly reported billions when they actually meant millions? No, the figures are real and big.

Just examine the Federal Reserve handing out banking reserves, without naming names (to keep banks from being embarrassed???) at emergency auctions? We could be looking at money leaving the banks at a rate faster than they can liquidate assets. "Emergency auctions" sounds like “Man the Lifeboats.”

The banking crisis is a little like the Hindenburg. It could go from something to nothing real fast. The only trouble is, who owns the something that's about to become nothing.

Saturday, December 15, 2007

Next Stop Inflation or Deflation?

Where is the country headed? We seem to be on the Sword of Damocles. Is it inflation or deflation? Where to from here?

In an inflationary scenario, debtors would benefit, it would be easier to pay back money borrowed. Those with savings would feel the tax of inflation. Each dollar would buy less than it use to (what’s new about that). Those on a fixed retirement income would suffer the most. Inflation is a way government can tax everyone. The neat thing is that there is no need for a tax collector. Plus you can’t cheat on your taxes. So when the government prints money, it’s kind of like taking a half bottle of whisky and topping it off with water to make a full quart. The buyer ends up with half the buzz at twice the price. Basically government is taxing one dollar and spending two.

Deflation on the other hand is a rough buggy ride for everyone. It tends to feed on itself and get worse (with government help). The economy slows down unemployment increases, bankruptcies and foreclosures increase. Prices drop and money buys more than it use to. Debts become harder to pay off when jobs are scarce. During the great depression, government services suffered greatly. Teachers, firemen, police and other services were cut severely. Congress could have a very serious problem if revenues from taxes collected decrease dramatically.

On the front page of today’s paper, San Diego readers saw a headline “Governor Schwartznegger set to declare fiscal emergency.” The State has a 14 billion dollar budget shortfall. That and all of the foreclosures suggest deflation is the current direction of travel.

There is just one fine wrinkle. Notice how government tax receipts are decreasing? There are a lot of fixed costs to be paid out, Social Security, Medicare and Medicaid. Uncle Sam has been spending the Social Security taxes as well as the regular taxes and even the gas tax on the yearly budget. When FDR wanted to stimulate the economy in the 1930’s with government spending, none of these liabilities were hanging around the government’s neck. The economy went to full power when Japan “remodeled” Pearl Harbor. Today's fixed costs for government entitlements, may force the government to print the funds necessary. That sort of inflation can spiral out of control.

Congress seems to think that spending is good, worry about the bill later. As government receipts decrease notice how the fixed costs consume a larger part of the pie. It’s a little like the foreclosure mess. Congress can barely pay the bills now, what happens when deflation takes hold? The expression “Between a Rock and a Hard place," comes to mind. Will they turn the dollar into Monopoly Money? Abu Dhabi just bought Baltic Avenue (Citigroup). Bye Bye worthless Dollar, Buy Buy our assets (a pun or two).

Sunday, December 09, 2007

Cash Only

When there is a run on a bank or other financial institution, the target has to raise cash to satisfy redemptions. Usually this entity would be fully invested to max out profit for depositors. To raise cash, the institution would sell its most liquid assets, stocks, bonds, money market funds etc, leaving the dogs, on the hope they improve given time. Notice good assets are redeemed for cash; the crap stays in the vault.

The State Investment Pool in Florida started out two weeks ago with 27 billion and shut the doors December 4th. Eight billion left the fund with no penalty. After the doors opened December 7, another two billion hit the exit turnstile. From Bloomberg

Florida schools and towns pulled more than $1.7 billion from a state investment pool in the two days since a freeze on their accounts was lifted, as local governments remained wary of keeping money in a fund with subprime mortgage-tainted holdings . . . . . . . . . . .

BlackRock, hired Nov. 30 to salvage the fund, walled off $2 billion of the weakest investments and imposed restrictions to limit withdrawals, including imposing a 2 percent fee on redemptions that exceed certain levels. Some governments have been willing to pay that price to get their money out . . . . . . . . . . .

Perry, the Jacksonville Electric Authority and Desoto County together paid $1.4 million in penalties yesterday to remove $66.7 million from their accounts . . . . . . . . .

This is what killed the banks in the 1930’s. The banking system collapsed not because of bad bank investments (no denying that there were plenty), they collapsed when depositors lost faith in the bank. Those first in line got their money, those last in line, got an education. The FDIC insurance stops the prospect of a bank run and keeps the depositors’ savings intact. These Fund Pools are not banks and are not insured by the FDIC.

An electric utility company and a county government agree to a 2% redemption fee of 1.4 million dollars. Maybe to act responsibly means you have to do things that are painful from time to time. If the investment pool can change the rules after the fact, whose money is it really? Could it be, these two entities examined their future accounts receivable, and figured out that the local economy has a few issues? They seem to know what they are doing. One turns off the lights; the other auctions off foreclosures.

Thursday, December 06, 2007

The Home Stretch

Lately pundits have been arguing over whether or not we are in a recession. At the same time the housing foreclosure mess is being addressed in the same fashion, as it was during the Great Depression (25 states passed moratorium laws on home foreclosures in the early 1930’s). The phrase “Déjà vu” comes to mind.

This five year moratorium on resets may backfire in a strange but consistent way. In California a few years back, the legislature realized that the spot price for natural gas for the utilities was a lot cheaper than their ten year contracted price. So they decided not to renew the contract and buy on the spot market. When the contracts expired the spot market took off like a rocket. The legislature meant well, it just didn’t turn out like they though it would.

A few years back, Congress passed a law to help farmers write down large farm equipment purchases over five years. Sounded great, every Realtor from here to nowhere bought a Hummer and wrote it off as a business expense.

In essence, teaser/exotic loans are gone, no more 2/28 or 3/27 loans. Everything from here out, is straight missionary style. The banks will draw a red line around California. Financing a home will become more difficult.

The headlines for tomorrow revolve around the five year freeze for home loans. The real story has been overlooked; the banks are in one hell of a mess. The possibility of one million families losing their homes would be tragic but most would be back to the regular old grind within a year. That’s not true for America’s financial banking system. Leave out the FDIC insured stuff. What is left of the rest is probably a USA (Up in Smoke Asset). IRA's and retirement funds come to mind.

I kind of get the feeling that President Bush just held the ribbon cutting ceremony for the Next Great Depression. Notice that you don't need an ambulance for this sort of catastrophe. You go to sleep well off and wake up poor. It's kind of like paying real cash for the hooker you had in your dream last night. It makes absolutely no cents.

Monday, December 03, 2007

Homeowner be Damned

So Henry Paulson is going to freeze the interest rates on home loans and Ben Bernanke is going to lower the Fed discount rate a whole point. It’s kind of like fishing with a shotgun in a glass bottom boat. You get a swimming lesson after you pull the trigger.

What happens when you freeze the interest rates? Go out and try to buy any house with financing, its just isn’t going to be there. What businessman will loan money under fixed assumptions only to be paid under a changing set of rules. Georgia a while back passed a law to protect homeowners and effectively shut down the loan industry in the state. This is the old “Pull the rug out from under the lender routine.”

Then we have Bernanke lowering the Fed funds rate. It doesn't take much thinking to figure out that the exchange rate on the dollar will fall. In this case, smart money will refuse to renew their Treasury Bills. Since it’s competitive bidding, less bidders, means higher prices. There is a couple of trillion dollars that could vote with feet. Foreigners will sell the dollar now and wait. Then buy when it hits bottom. If things don’t go right, this could be like catching a bag of cement dropped from a second floor window (messy to say the least). Treasury bill rates could surge up as soon as tomorrow.

The neat thing about lowering the Fed funds rate, is that any money it does create (ie loans to market makers), won’t be heading for real estate or SIVs, it will be going into the stock market. Google could hit $1000 by Christmas (just a joke, I don’t give investment advice).

So what do we have? A shut down of future real estate financing or the prospect of absurd interest rate financing for home ownership. Flight of foreign capital will raise Treasury rates.

What is really happening at the Bernanke and Paulson level? The banking system could collapse. Unless they can keep the homeowner making payments the game is over. In order to keep the banks from dropping dead, the really bad stuff cannot be allowed to be marked to market.

Step back and think about what has happened in the last two years with Real Estate Bubble Bloggs. Many of them have stopped posting. What they were warning about has happened. It was very obvious even back then. Now, all of a sudden, the Government is concerned about the homeowner? I think not. The banks have a pretty good idea of what’s going to happen three months from now. Citygroup has no equity if you subtract its mistakes from its book value. What’s that mean? The government could be called on to take over an organization that is just about half as big as itself.

Ben and Henry are in that Christmas giving mood, so don’t bend over if you need to refi, just walk away, give yourself and your family some real peace of mind.

Saturday, December 01, 2007

Citigroup is Toast

Several banks are forming a consortium to make a market for SIVs. Citigroup holds about 100 billion dollars worth. Coincidently this is about the amount this group is going to raise. These instruments are a little like intestinal gas. It reminds me of the two immigrants, new to the US, taking notice of several balloons tied to an outhouse door. The one remarks to the other, “I’ve heard them, and smelled them, but this is the first time I have seen one!”

To keep the discussion polite, Citi/Shiti has some balloons for sale. They are rated as Chiti. I know we haven’t lost the short bus group, they all know the “Pull my finger drill.”

Needless to say, where does the 100 billion come from to make the SIVs fungible? The answer is so obvious that it boggles the mind, BAT GUANO FUTURES (Just Kidding). But the people out there that everyone is listening to, expecting a solution from, are part of a certified circus act.

Let’s see, you are a bank and you lost 100 billion dollars. The total cost to tax payers for the S & L fiasco of the 1990’s was only 125 billion. We have one bank with a very bad cough and more obligations on debt than the previous banking brouhaha in total.

What’s a 100 billion? The answer depends on who you ask. The one question not asked, is what bank can survive a 100 billion dollar loss? In my opinion, none. Citigroup is toast.