2 HEADED MONSTERS - BILL GROSS' BINARY WORLD

I read the 2012 outlook from Bill Gross this week and wanted to make it available and make some clarifications about his thoughts and also highlight how powerful it is that this controller of literally hundreds of billions of dollars has gone so negative on the outlook for the global economy.

Below is the link;
TOWARDS THE PARANORMAL

In this post, Bill Gross revisits the term "New Normal" that Mohamed El-Erian had made common place when referring to a low growth, stagnant global economy.

"The New Normal as PIMCO and other economists would describe it was a world of muted western growth, high unemployment and relatively orderly delevering. Now we appear to be morphing into a world with much fatter tails, bordering on bimodal. It’s as if the Earth now has two moons instead of one and both are growing in size like a cancerous tumor that may threaten the financial tides, oceans and economic life as we have known it for the past half century. Welcome to 2012."

Where Gross is really focusing on is this idea of a distribution curve where there are two really bad outcomes at each side of the distribution of events.  Unlike the unforeseen black swan eventst, Gross is suggesting that the probability of the worst outcomes is increasing and therefore he references the "fat tails". (In a normal distribution the tails are small).

THE PARANORMAL
Gross describes where we are as we enter 2012;

"The financial markets are slowly imploding – delevering – because there’s too much paper and too little trust. Goodbye “Old Normal,” standby to redefine “New Normal,” and welcome to 2012’s “paranormal.   

Perhaps the first observation to be made is that most developed economies have not, in fact, delevered since 2008. Certain portions of them – yes: U.S. and Euroland households; southern peripheral Euroland countries. But credit as a whole remains resilient or at least static because of a multitude of quantitative easings (QEs) in the U.S., U.K., and Japan. Now it seems a gigantic tidal wave of QE is being generated in Euroland, thinly disguised as an LTRO (three-year long term refinancing operation) which in effect can and will be used by banks to support sovereign bond issuance. Amazingly, Italian banks are now issuing state guaranteed paper to obtain funds from the European Central Bank (ECB) and then reinvesting the proceeds into Italian bonds, which is QE by any definition and near Ponzi by another."

Not exactly mincing words is he?  Gross continues to state that in reality, global credit markets are actually EXPANDING mildly rather than what should be happening through normal events we've been through.  Extra normal intervention of central banks and politicians is having the effect to push credit expansion rather than contraction.  Gross explains that INFLATION is one side of the distribution; one of the "fat tails".

THE FED SURE LOVES ITS INFLATION DOESN'T IT?
On the other side of the curve we have the following;

"At the other tail, however, is the potential for “implosion” and actual delevering. To the extent that most sovereign debt is now viewed as “credit” in addition to “interest rate” risk, then its integration into private markets cannot be assured. If only Italian banks buy Italian bonds, then Italian yields are artificially supported – even at 7%. If so, then private bond markets and non-peripheral banks in particular may refuse to play ball the way ball has been played since 1971– purchasing government debt, repoing the paper at their respective central banks and using the proceeds to aid and assist private economic expansion. Instead, fearing default from their sovereign holdings, any overnight or term financing begins to accumulate in the safe haven vaults of the ECB, Bank of England (BOE) and Federal Reserve. Sovereign credit risk reintroduces “liquidity trap” and “pushing on a string” fears that seemed to have been long buried and forgotten since the Great Depression in the 1930s."

DELEVERAGING  IS A NICE WAY TO SAY DEFLATION
Here, Gross suggests that the other side of inflation is the repudiation of ponzi debt and the notion that central banks efforts to stave off credit implosion through debt purchases could result in absolutely nothing meaningfully good, and ultimately tax-payers eating a lot of defaulted debt.

 Well, central bank efforts have worked previously, why not now?  I've discussed this reason many times, the Fed has worked itself into a box of zero interest rates now, and that amounts to them trapping themselves with little room to work.  If rates are 25bps how much farther can they go?  If the Fed dropped rates to zero and the ten year US Treasury fell to 1% through additional bond-buying activities (QE) does that buy them incrementally anything?  Does more liquidity available do anything at all when the world is swimming in USD?

NO, zero bound money makes yield investors freeze and these buyers state that all they would really desire to do is keep their money safe given that when they deploy it and invest, they are really taking significant risk adjusted risk for very little return.  Why is that?  When was the last time your broker told you that money markets could lose money?  When was the last time you thought about your brokerage firm freezing your money in accounts like an MF Global situation?  Situations like these make investors that rationally examine risk state that they will forego investing in anything to ensure the safety of their money.  Essentially, the desires of the central banks to stimulate asset demand ultimately can have a chilling effect on investing that is exactly opposite to what they intend.

So what does Bill Gross say the Fed will do about this growing conundrum?  He says that they will actually signal in their January meeting that they intend to hold interest rates low even longer, perhaps as long as 3 years!  

INVESTING OUTLOOK
What does Mr. Gross say investors should do in response to the 2 potential outcome disaster scenarios?

Bond Investors -
1)  Extend out maturities and bond duration.  With a signal from the Fed it won't raise rates for even longer, essentially you are protected from rising rates and the losses on bonds this imposes.
2)  Invest in US Treasuries, not Europe.  Go 6 to 9 years out, not less because you get paid nothing.
3)  If you are buying long dated US Treasuries, they better be TIPS
4)  Corporate bond holdings should be in the higher grades of debt, not lower.  Again, he suggests some financials here and I think he is off his rocker.
5)  Munis could be a good opportunity --- PERSONALLY I THINK HE IS NUTS, but then again, Pimco has to invest in long maturity bonds, but I wouldn't touch them.
6)  No EU bonds.

Stock Investors -
1)  High yielding dividend payers is what he says to go after.  Look for companies with stable cash flows like utilities and big healthcare (pharma).
2)  Commodities - Gross is basically flipping a coin here saying it could go either way.

Currency -
He gives us no real insight, simply saying that in deleveraging the USD is awesome and in inflation, it sucks.

SUMMING UP - DID HE REALLY SAY THAT?
Finally, Gross puts it all in perspective with this last parting shot;

"For 2012, in the face of a delevering zero-bound interest rate world, investors must lower return expectations. 2–5% for stocks, bonds and commodities are expected long term returns for global financial markets that have been pushed to the zero bound, a world where substantial real price appreciation is getting close to mathematically improbable."

What?  Investors had better begin to expect 2% to 5% returns from all asset classes?  Is he serious?  I presume he is dead serious and this is the real issue.  I still have discussions with friends that expect 10% returns or 12% returns and I ask them where you plan to get that?  The reality is that yes, you can get those returns, but the amount of risk you take in the investing environment today is off the charts.

THEY BOUGHT US TIME, NOT MORE ROPE
I will say it again, daily moves up and down 3% indicate that the market is having a death-rattle event, not that it is healthy and invigorated.  I am suggesting that the very underpinnings of the market itself is heaving and struggling and these are the last gasps and fits of life in this dying beast. It seems as though Bill Gross agrees.  Gross doesn't say it, but I think he is calling BS on all work of the Fed and realizing that they have gained us absolutely no material and meaningful improvement for lots and lots of bailouts and manipulation.  We are at the end of our rope and essentially the Fed has only bought us time over the last three years, not more rope.

NOTHING IS BETTER, THE BIG ONE IS COMING
In a way, I feel like the comments of Bill Gross echo the sentiments of a video interview Kyle Bass did a couple of months ago, where Bass lamented that we are in a "Binary Outcome" situation with the Euroland.  Bass described the Euro situation as a scenario that results in either the implosion and collapse of the financial system or they are saved.  While Bill Gross extends a bit more of the "curve" in between nasty outcomes, the thrust of the statement is the same, nothing is better, and the big one is coming.

GOATMUG

Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments at http://www.goatmug.blogspot.com/

 

 

 

WHY TELL THE TRUTH WHEN YOU CAN LIE? (US TREASURY & THE FED)

SAME STORY, SAME LIES
If you read economic news long enough you will start to see the same tired story spun the same way over and over and over again with little variation.  This is especially true when listening to the President, CONgress, the Fed, and the US Treasury.  It is not surprising to see this because people (leadership) tend to give the people what they want to hear rather than what they need to hear.

Think about it.  We have an government that is spending in an out of control fashion like a shopaholic, we have a deficit that is greater than $1 Trillion more than we take in, we have hit the demarcation point where Social Security and Medicare are spending more than they take in, we have a Federal Reserve that is buying our own debt keeping rates so low older people can't earn enough, we have exceeded our self-imposed government debt limit, and we have a banking system that is really insolvent.  Have you heard any of this stuff really discussed in an open forum or seen the leadership come forward and propose a real plan that is thoughtfully considered? 

The answer is no.  Even President Obama has completely ignored every single recommendation that his own budget deficit reduction panel provided.

TWO GOOD ONES THAT EVERYONE LOVES TO HEAR
So, it is odd to see someone other than fellow bloggers generate a post or article that states something other than the normal bilge of conventional wisdom or sound bites.  Today, I found one piece that actually stuck out, because it flies directly in the face of what we hear from Treasury Secretary Timothy Geithner.  In fact, recall that every single time Tim Geithner speaks he states several lies over and over again.  Here they are;

1)  The USA believes in a strong dollar policy!  HAHAHA!  Remember when he said this in Beijing and the Chinese business students simply laughed out loud in his face?  That was one of the funniest common lies.  We Americans are either too polite or too stupid to do anything but nod our heads when he says this to us. 

(Totally unrelated video, but really funny considering these are the folks that are laughing at our Treasury Secretary!  Oh and by the way, don't click the video when it gets going, I have no idea where it will take you)
2)  Mr. Geithner also is fond of telling us that China is bad and that their currency is undervalued.  In other words, we are looking for a scape goat to complain about our trade deficit and this one has been an easy one to throw out there, because Americans are all about "Good Guys" and "Bad Guys".  (Don't get me wrong, those Communist Chinese are bad guys, but that is not the point of this post).  When Geithner says, "Chinese are bad", we all pile on and clap and howl and scream, and CONgress does the same thing too.

WHO LET THESE GUYS WRITE THIS STUFF?
Given that Geithner loves to throw these two out, I found it remarkable that the St. Louis Fed wrote a one page note stating that in fact, that perhaps it wouldn't be a great thing if China did actually revalue their currency higher.  They mentioned that the yuan had actually increased in value by almost 25% since 2005 and yet it did nothing to stall the increasing trade deficit with the most populous nation in the world.    Further, if we did have a Chinese currency that was valued higher, WE IN THE USA would have a HIGHER INFLATION RATE!  In other words, things would be much more expensive if the garbage we buy from China cost more (via an appreciated and more expensive yuan). 

http://research.stlouisfed.org/publications/mt/20110601/cover.pdf?utm_source=Twitter&utm_medium=SM&utm_campaign=Twitter

(Go ahead and read it, it's 1 page!- make sure that you right-click and open in a new window though!)

Yes, that is the take away, while we've simply swallowed the trash that our leaders provide to us, we often never question the extent of their understanding or their ability to actually tell the truth.  The St. Louis Fed says that we'd have more inflation here.  But beyond that, you know what would really happen.  If China appreciated their currency we'd have importers and businesses going to Thailand, Malaysia, Vietnam, and every other 3rd world poverty stricken country looking for cheap labor to replace the suddenly more expensive junk from China.  I guess that then Geithner could complain about those countries and their terrible trade policies and deficits huh?

Ultimately, Mr. Geithner, The US Treasury, The Fed, CONgress, and the President don't want to address the real issues, we want to point fingers at others and sink our heads in the sand.  The St. Louis Fed document is interesting, but certainly is something that won't be repeated in interviews or Sunday morning talk shows.  It is far easier to blame others and refuse to address real issues.

WHO WROTE THIS? - NICE DISCLAIMER!
Oh yes, it didn't escape me that the authors of the paper just happen to have interesting sir names, perhaps these folks went off the reservation or we'll soon find that Chinese spies have even infiltrated the highest ranks of the Federal Reserve system.
(Mingyu Chen and Yi Wen were the authors).
Finally, you have to love the disclaimer at the end - Perhaps I'll start adding that same disclosure to everything that Goatmug writes as well..... so here goes.

"Views expressed do not necessarily reflect official positions of the Federal Reserve System".

GOATMUG

2010 YEAR IN REVIEW - DREAM BEFORE A RUDE AWAKENING

As briefly as possible I want to transition from 2010 to 2011.  I will keep this year-end review separate from the outlook for 2011 because I want to make this post shorter and more manageable.  I know I can ramble and go down a few bunny trails so I'll just reflect on what I thought might happen and evaluate how we did.

In the Outlook from the Mountain Top for 2010 I made quite a few projections ranging from where gold and oil might trade to world geopolitical events to domestic policy outcomes. In total there are about 16 or 17 concrete ideas we can evaluate in the post found here - OUTLOOK FROM THE MOUNTAIN TOP FOR 2010.

In total, I believe that I was 8 out of 14.  Some of the projections I will concede that I was wrong because I laid down hard and fast numbers, but were directionally correct (3 of them) - but..... I don't want to give myself credit cause a miss is a miss (remember, I'm old school where not every kid gets a trophy just for playing...only winners get trophies). 

So, let's look at the major issues.

INTEREST RATES - (MISS) - timing was off, but it is coming!
Complete miss here - Interest rates on the 10 year treasury started the year at 3.85%.  As our Federal Reserve invoked the power of QE I we saw the power of their printing press and the ability to use those proceeds to impact the bond market.  10 year treasury rates dropped throughout the year to a low of 2.41% as of October 6th.  Interestingly though, since October 6, rates have jumped to a rate of 3.38%.  So, as I look at this projection, it appears as though I under estimated the appetite of the FED to attempt to become the bond market by buying the amount of bonds they have (they almost own $1 Trillion of treasuries and MBS) and also under estimated the insanity of the Federal Reserve to take on this kind of interest rate risk.  Consider that if interest rates move 1 basis point against the FED (up) they will lose $2 billion in a market to market of their position.  Thank goodness that the government doesn't make anyone mark to market!

Since 10/6 the market seems to have decided that it will call the FED's bluff and see exactly how much and how deep their commitment is to purchase this trash.  The 2 month move in yields isn't troublesome yet in a historical perspective, but I would be worrying if I were Uncle Ben if rates get over 2010's 3.85%.

I'll write more in the next post about 2011 to discuss exactly why rates are doing what they are doing and how this actually may be part of the Fed's plan rather than what many have described as Uncle Ben fiddling as the US burns.

HOUSING -  (HIT)
I nailed this one.  Housing has double dipped and is a mess and getting more messy.  If interest rates go any higher you can forget about the promised housing recovery.  In my book, it is done.

CURRENCY DEVALUATIONS - (HIT) 
Yes, this too was correct and we'll see many more as emerging countries cannot deal with the pressure that the US is putting on them.  By attempting to devalue ourselves andcreating inflation here, we are exporting deflation there and these countries absolutely need to keep a relative position to us in trade.  They will want to combat that and they have done it by cutting the value of their currency.  Now other emerging countries are attempting to stifle rampant inflation like India and China by raising interest rates.

FANNIE / FREDDIE - (HIT)
Yes, these are a disaster and they have been the dumping ground for all the bank trash.  This is a ticking time bomb that will deliver a massive body blow to the budget and economy of the US.  The good old banks got us again.  Good thing the taxpayer has a bottomless pocket to absorb all of these losses.  Thanks CONgress.

EURO (HIT)
Yes, and it isn't through.  The Euro's decline is a symptom of the sickness in the Eurozone.  We will continue to see this plummet.

LENDING - (MISS)
Lending actually has picked up.  This is a miss.

GOLD - (MISS)
Because I projected a year-end level of $1,200 on gold, this is a miss.  Directionally this is correct, but I didn't anticipate that gold would really become that ANTI-CURRENCY thing that it has become.  When people do not want to risk holding any paper or anything, they have bought gold and it has now become its own asset class.  Each time we see a tremor in Europe that reveals that Greece, Italy, Spain, or some other country is on the ropes, gold launches higher.  In my estimation we will not see an abatement to this trend as there is no fix to the Eurozone crisis unless leaders there man up and kick these countries out of the EU and force bond holders to eat losses.  Of course they don't want to do that because that will cause all of their banks to implode.  So back up the truck and buy more physical on any pullback.

EQUITIES - (MISS)
I projected that stocks would be up around 5% this year, they pounded out returns of near 12%.  Clearly my understatement of the Fed's approach to QE was a major factor in missing here.


ISRAEL - (MISS)
I suggested that there would be an attack on Iran, and there was one, yet it wasn't the type of physical attack that I suspected.  Because I missed it, I'll call this an official miss, but it wasn't.  In recent months we have learned that someone (Israel is suspected) uploaded a virus into the nuclear systems computers at several sites globally.  What is amazing though is that this virus seems to have been extremely targeted.  It looked for specific types of equipment and operations components and had the capability to turn on and off specific processes that would damage components.  This sophisticated attack seems to have delayed and destroyed the capabilities of Iran to push forward in its campaign to develop nuclear "power".... errr weapons by 1 or 2 years.  If you want more information on this compelling attack simply google Stuxnet.  While I completely support this, it is very scary to think that a government or group of cyber programmers could do this.  Clearly this means that our electrical grid and anything else in the United States is subject to the same attack.  I am not naive enough to believe that this same technology won't be used by another government or terrorist group in the future.

OIL - (MISS)
When I project that oil would hit $100 a barrel it was at $72.00.  Today we closed around $92.00  Again, because I put a specific level I'll call that a miss, but directionally it was dead on and would have been a great gain if you went in that direction.  Energy will be one of the big winners in 2011.

US POLITICS - (3 HITS)
All three of my projections hit home here.

NATIONAL SECURITY - (HIT)
Yes, our national security apparatus continues to erode personal liberties in the name of protecting us.  Government does not self-limit and continues to desire to grab and obtain more of an individual's right to success and failure.

There you have it.  Decent, but missed on a few.  The year was volatile and was one that in my opinion is a set up to a really difficult year in 2011.  Most of the CNBC gurus are projecting a great 2011 and I just don't see how it happens.  There are storms brewing and each of these guys continue to act like we can pretend that the storms won't actually come ashore.  The year will be marked by how Europe and it's bankers... (the FED and IMF) handle the problems in Spain, Portugal, and the other broke countries.  Additionally, the emerging markets trades that have been so supported here on this blog will become trickier as higher commodity prices will suppress growth in those countries and will possibly crush domestic US consumerism. 

Unfortunately, this is a time when those that are awake are asking where the leaders are, but in the US we don't have any that are worth their salt.  The US is led by an economic captain that is super clever, absolutely insane, or acting on behalf of those that have interests that are not in line with the US and its citizens.  Our political captain is an amateur that is driven by big ideas that have no real value or substance outside of dope smoking academic dream worlds.  We see this in his approach to health care, economics, energy policy, and foreign policy.

In summary, 2010 was sort of like a dream year where it defies logic and reality and simply progresses on a path of inertia fueled by the Fed's electronic printing presses.  2011 seems to me to be the year when reality shakes us from our dream-like state and unfortunately reveals that we have real issues that should have been dealt with previously.  America once was a country that was made up of rugged individuals that had a moral compass and would rather do the right thing than the quick and easy thing.  I am afraid that while many of us are still cut from that cloth a substantial portion of us have become soft and more concerned with today than tomorrow.  The need for instant gratification and the belief that someone in government can solve problems and should solve them has transformed many into something less than the proud Americans we once were.  It is without a doubt that even if a majority of US citizens are independent and strong we have elected leadership that doesn't adhere to our same principles.


WRAP UP
Thanks for making 2010 a great year.  May your family be blessed.  Email me with questions or post comments, I relish knowing that someone actually reads this thing!  On that note, I'm excited to see that the blog is getting around 1700 visits a month now.  This isn't much compared to many of the big blogs I read like Slope of Hope and Mish's site, but 1700 is a ton as we started this thing with zero readership!

I'll post the 2011 Outlook soon.
BECAREFUL!

GOATMUG 
http://www.goatmug.blogspot.com/  

JAPANESE CENTRAL BANKERS GET IN THE GAME! (CAN THEY LEAVE AT THE TOP OF THE HILL)

A super quick snapshot (who can do more than that at 12:49 AM in the morning?) on the impact that our Japanese Central Bankers are having as they intervene in the currency markets.  Essentially they are attempting to force the Yen down because the strength of their currency is hurting their companies as they try to export to world countries.  Since our (the world's) currencies are worth less it takes more of our currency to buy their products.  In the world of global competition, this is a no-no.  No one wants a strong currency, just ask the Chinese - they have artificially weakened theirs for years in an attempt to dump their junk on us and keep the prices low.

As I stated many times, ALL of the central bankers will join the race to zero interest rates and keep the "growth of the economy going".  When their policy tools have been exhausted, they sometimes rely on the mechanism to attempt to spur asset price increases by attempting to drop the value of their currency.   In stating this, I made the prediction that we'd see some (several) major currency devaluations this year.  The Japanese are doing their best to get in the game.

As of now, here are a couple of screen shots of my favorite site to check on the status of the Nikkei when I can't sleep, or am about to drift off into a pleasant dream.  If you want a real time Nikkei update this is a good site - http://e.nikkei.com/e/fr/marketlive.aspx

So, what is the result of all this intervention?  Well, just as we see here in the USA when the central bank makes efforts to devalue the currency, the stock markets lift off in a celebration!  But like most parties, the happy times usually don't stay that way.  Back when I used to drink I used to have a saying that you needed to leave a party "At the top of the hill".  That usually meant that when I was having the best time it was a signal that I needed to leave.   Unfortunately we've seen that central bankers have no concept of leaving before the party is overdone.  Their history of blowing bubbles and pushing easy money and lax credit on undeserving consumers is well documented.  Why would we expect the Japanese that have tried these measures many times to be successful now?  While the party may continue for a brief time, this should set us on alert for a new rise in the yen (after it drops for a couple of weeks) and for a new fit of competitive devaluations from central bankers all around the world.  We can't let the Japanese have all the fun can we?

If you own Toyota (TM) and you get a nice pop on the move perhaps you should consider leaving while your at the top of the hill.

Who gets hurt in this?  Well, first off, any trader around the world that was long (held) yen.  The drop in value of the yen could really damage a trader's account especially since most traders use leverage (borrowed money) to create out sized gains (and losses).  Second, a Japanese citizen that is looking to purchase goods from outside the country can now buy less of that good with the same amount of yen.  Finally, if this could somehow actually create inflation in Japan (it won't) then holders of those awesome Japanese bonds that yield 1% interest each year could see the value of their bonds clobbered.  Now it is important to note this isn't an official devaluation like we've seen from some of the emerging markets countries, but the impact is clearly focused at intervening to drive down the value of the yen.

Be careful.

GOATMUG



Give Us Something To Believe In

I wrote this article and submitteed it to Tim Knight's Slope of Hope. He usually will post my contributions only on the weekends because they are so long, so I will go ahead and publish it here in case it doesn't fit with his year-end line up. I will post a very quick (I know-I promise it will not be lengthy) updates on where I think the market is from a trading perspective and how to look at the positions we've mentioned in the past. Right now other than the last piece of my KSU that I exited this morning I have no positions.

I've documented the history of actions that caused our crisis and outlined the steps our government has taken to "bail us out". You may find the most recent post at Goatmug's Blog where we discuss The Best Cup of Coffee Ever and how it seemed wonderful and solved all of my problems, yet ended up bitter and disappointing. As I've mentioned, I believe many of the steps taken have either not worked at all, created other problems, or simply hidden the problems. Let's take a few of the items I pointed to in the last post and review the impact and results of their actions

A) The Federal Reserve and Treasury along with other world central banks stepped in and offered their fiscal support and immediately lowered rates again to near zero. Remember, these are front month rates and are the interest rates the government charges banks for overnight money. The Fed voted in recent weeks to keep rates stable at effectively zero percent interest. They voted to do so some 18 months since the beginning of the crisis and 9 months after the beginning of what we now know as one of the largest rebounds in stock market history. In spite of the rally we are still around the 10,500 level on the Dow which is where we traded in January of 2006 and well below the lofty 14,000 area of October of 2007. Am I saying that we cannot return to these areas? No, in fact if the Treasury department remains committed to devaluing the dollar, I can paint a scenario where that might be a real outcome. I doubt it seriously, but it could happen.

Timothy Geithner gave an interview last week on NPR that should put us all on notice. In his words, we will not have a retest or slowdown after this recession. Although many of his other predictions have been flat out wrong, I have a strange sense that he is committed to not letting that happen no matter what. http://www.npr.org/templates/story/story.php?storyId=121778778

Mr. Geithner is only speaking of a short term pull back that he'll help us avoid, for it is too obvious that the Fed and Treasury actions create bubbles and meltdowns and they are coming with increasing speed. I liken this to a drug addict. At first there is pleasure in the use of the substance. Next there is dependency, and then an increasing need for the larger portions of the drug in greater frequency. Think about friends, family members, and others that fit this drug addict description. It usually never has a happy ending does it? I think what we're about to experience is "tough love" provided by our investors. Our friends, (Chinese, British, folks in the Middle East), are about to hold a frightening intervention with the addict and therefore we will be told that we need to shape up and cut out our drug abuse. Unfortunately, I don't think the addict will listen. It is too tempting to let all of that debt go to waste and too hard to cut spending and cut promises and entitlements.

So what are the results of these actions? Interest rates are still low and creating asset bubbles. - Banks and other bank holding companies...er investment banks and insurance companies can now borrow at zero overnight and buy stocks, bonds, and commodities. Is there any wonder why all markets are screaming? What happens when that money is taken back? Remember, this money was intended to buttress balance sheets and also intended to be lent out to companies and consumers, not find their way to the casino!

Banks receive this money and will lend. - NOPE! This has not happened. This I believe is one of the greatest lies that has been made in this crisis. Why would any smart banker lend in the teeth of a nasty, jobless recession? Would you? If you looked at a firm that is asking for credit and he tells you that their business is slowing and they need a loan to make payroll, do you think they are a good risk? Asking bankers to lose money on bad loans is not a solution to the crisis. On a positive note, I am hearing some of my clients being contacted by banks that are desiring to lend on decent terms now. This may be an indication of some thawing.

B) The Fed also bought toxic securities outright from troubled financial institutions and traded those assets for treasuries. Our government offered the TARP funds to help institutions and even made outright purchases of banks and insurance companies. (AIG, Citbank, etc.) We even used these to buy and lend stakes to great car companies like GM! We keep reading that many of the banks and insurance companies that we lent TARP money to have repaid us and we (the US taxpayer) may have actually made some money on these loans. The reality is that we may have made some money on loans that have been repaid, but we have taken a bath on the loans that will never be repaid. Making AIG a government controlled entity makes certain that more losses are headed our way. The Treasury Department and Fed's lack of negotiation with AIG's creditors should be enough to convince anyone that the well connected firms like PIMCO, Goldman Sachs, and Blackrock were feasting on the carcasses of weakened and dying financial firms. In addition, these same favored companies have become the mechanism by which the FED and Treasury actually implement their policies. These companies are providing transaction support (spreads), participating in deals, and also offering consulting services

So what are the results of these actions?
AIG is a mess and still 85% owned by the US. Isn't it great we are in the insurance business?
GM - is still GM.
Goldman, Blackrock, and PIMCO are killing it .

Remember too big to fail? - As a result of the forced marriages between JPM and Washington Mutual, BAC and Merrill Lynch, Wells Fargo and Wachovia, we now have a greater concentration of larger institutions. Seems like the US government has now created larger risk pockets and concentrated more power in less hands. Finally, the repaid TARP money is being used like a slush fund now. The administration and Geithner said they had "extra TARP money" that they could use! Excuse me, just because it is appropriated doesn't mean we need to use it if everything is all fixed, right?
C) In concert with these actions our government also looked to perform direct support (cynics would call it manipulation) in the mortgage market and the treasury market. By guaranteeing and supporting the FHA the US taxpayer became the lender/insurer to 80% of the post-collapse mortgage market. With the announcement of quantitative easing by the Fed we began buying our own treasuries to try to keep prices low and contain rising interest rates.

While short-term manipulation has been successful, it is just that - short term. The bond market is bigger than any one central government and the bet made by Bernanke is going to be called. Once that happens interest rates will climb (and as I type this we are seeing 30 year mortgage rates 10bps higher in one day last week!). THIS IS A HUGE MOVE BY THE WAY! Who will step in to fill the void of the government in this volume at these rates? Stabilizing the home market is job #1 - The government has artificially lowered interest rates and become the dumping ground for all banks to offload their paper on the US taxpayer. Few banks are doing direct lending to residential borrowers without FHA backing. Home sales look to be moving up, but we must ask how long this will continue if rates jump substantially, cash for houses go away, the FED stops buying MBS (stops being the market), or banks actually release the huge backlog of foreclosures that they have kept on their books.

Don't get me wrong, the government is having an impact here and this is positive for the economy. I'm very concerned that this could change if any of the government "help" is removed or investors demand higher rates and push mortgages rates over 6%. For example, in November we were to have the final expiration of the first time home buyer credit. Sales were pulled forward and suddenly we have a reported drop in new home purchases in November. The following Bloomberg article demonstrates what the threat of pulling stimulus does. A mad rush of buyers that would have bought anyway step forward to take advantage of the taxpayer-paid windfall, and then demand dries up in the following months (Cash for Clunkers anyone?). http://www.bloomberg.com/apps/news?pid=newsarchive&sid=al3GTnIut0Ao

Obviously I'll have this prediction in my top predictions for 2010, but I'll suggest here and now that we have a dip in the sales trend in existing homes as much of the inventory that has been clearing has been foreclosures and investors (not occupants) have been swooping in to pick them up. Hopefully those investors have been buying smart and have deep pockets because I will predict that we'll see the new generation of home flippers that have emerged get sunk in 2010. They'll find that there won't be many buyers for these homes when mortgage rates hit 6% or 7% since we're all spoiled and believe that 4.75% is what we should expect! These investors will also get hit hard when banks like Wells Fargo and Bank of America actually release their piles of inventory instead of letting them trickle out. Look for these inventory clearances after 1st quarter reports come out.We were told that housing is the key to recovery - housing has not recovered yet, so I guess there is no recovery yet.

D) The Obama administration got in the act and began programs like the Housing Tax rebate for first time home buyers, Cash for Clunkers, and now Cash for Caulkers. In addition, the federal government has continued its payment of extended unemployment benefits. In addition, as a country we are now running a huge fiscal deficit (nothing new, just the magnitude of it is) and our government's expansion has required us to raise the debt ceiling (allowable debt of the country) to $1.8 Trillion Dollars! This doesn't even account for the addition of any new health care program or new stimulus. As I've mentioned several times, I believe that the Fed and Treasury must be cussing the administration for their interference. The Obama administration has kept to their strategy that they wouldn't waste any crisis and by goodness they haven't. In the hysteria they have continued to plunder the US taxpayer and add more programs and benefits to the entitlements for anyone that will take them.

We are now seeing that COBRA subsidy benefits are being extended to the unemployed (they have been offered for 9 months) and will be provided for another 6 month period. The program pays 65% of the premiums that someone that has been laid off of work must pay to keep their health insurance. It seems odd to me that the US Government and US taxpayer would pay for health plans at rates that are significantly higher than what can be obtained by families in the open market with individual policies. Of course we shouldn't be amazed at all about this, this is what happens when government makes decisions. This one example illustrates how the new health reform plan cannot and will not be an improvement or a cost savings for anyone.

While Obama has added his pork to the budget, the US treasury buyers will not tolerate the bloated debt of the USA. The market will require higher rates of interest and this will cause significant pain for all of us.
Crisis Management- Administrations have added pork laden projects and plans to the backs of taxpayers as an excuse to stimulate the economy. There are no plan for fiscal restraint or management of the budget. What simply blows me away is that I hear Obama speak about finding waste in government programs to pay for more stuff! Where is the idea that you cut costs and if necessary, benefits?

I'll comment more about the health care reform bill in another post, but you need to understand that the winner here is the health insurance industry (for now). As these bills are written they will have a captive audience of buyers. Many of you know that I own a health insurance brokerage and I saw a huge swing in commentary by insurance companies. If you don't think they are giddy, you are WRONG! Check out this email link I received from Aetna. These guys were hammering the Senators and then suddenly came out with this gem. Mind you, if this goes through I hope to sell everyone one of you a policy because I would hate to see you go to jail or pay stiff fines, but everything about this stinks and reeks of over promising and under delivering at a terrible cost to tax payers. A key provision in the plan is the elimination of pre-existing conditions as a basis for exclusion or rating up. Once this exclusion provision is removed we will witness the elimination of INSURANCE! Why would you obtain insurance till you have something serious now? GDP was revised downward and we are seeing that the government is responsible for most of the production for last quarter. I understand that

For all of these programs, what are the results? - We were told we need these programs to stimulate the economy- all have been short term and have done nothing to change the fundamental situation. We still have 10% unemployment and 17% U-6 unemployment. We were told that everything would begin to get better once housing is stabilized, we haven't seen housing stabilize and won't for a while. More appropriately we'll see things stabilize when people have jobs.

E) The accounting standards board (FASB) bowed to pressure from financial institutions and our government by suddenly recommending that accounting standards be thrown out the window. The accounting standards board have been complicit in this crime against investors as the boards were threatened and frightened into thinking that they would be responsible for imploding our economy. Where is the leadership in our country? I am afraid that the move to take a time out on reality simply makes it easier to do it again. The accounting standards board should have stood up and emphatically stated that accounting standards don't change or take a time out because the truth hurts! Future collapses will be much worse because the ponzi schemes the government and banks have set into motion were not stopped here. Clearly now that the banks are bigger and risk more concentrated similar meltdowns will be even more destructive. Accounting standards were thrown out resulting in a lack of understanding of true value of banks and insurance companies.

Where are we now? We still don't know what banks are worth and they are still raising capital and still lying about the risk on their balance sheets.

F) Finally, as we saw in the previous October post called Public Enemy #1-Deflation we see that the Fed and Treasury unleashed its last desperate weapon, Dollar Devaluation. The dollar devaluation trade is simply a move to destroy the value of the dollar relative to other currencies. This makes our dollars worth less and hence our debt worth less. We could also argue that it makes our goods cheaper as we hope to sell them abroad. The Fed has been true to its words that it would implement this strategy if faced with the prospect of deflation. When the government went to work in March the DXY was at $89.20 and they did not disappoint. They have moved the value down by as much at $15.00. The DXY is now trading at 77.64, well off its lows of $74.27 in late November and early December. So as the dollar has been pelted since March, EVERYTHING has gone up. Think about it, stocks, bonds, bread, gas, oil, gold, and the kitchen sink have all increased. http://www.marketwatch.com/investing/index/DXY/charts?chartType=interactive&countryCode=us So now, we've been told that everything is better and that we are recovering. In fact about 3 weeks ago, we had a surprisingly strong jobless claims report that stunned the market and boom, the dollar reversed course and interest rates began to rise. They rose because the strong jobless report indicated that things were stronger than expected and the Fed might need to remove stimulus (increase interest rates or as we know it, take the drugs away from the addict). Since that day there has been a resurgence of the dollar. Bernanke tried to tell the market that they would not raise rates because there were no indications of inflation in the market. Fed governors tried to tell us there was no evidence of inflation, and now Geithner has come out and told us that there is not a chance that we'll have a double dip.

So why are rates starting to rise and the dollar increase? How have we seen the dollar rise and the markets increase? First we have had some credit issues with Dubai, Greece, and Spain. All of those have reminded investors that there really is risk in the credit market and we aren't fully recovered. Scared investors tend to go to safety, and therefore we have seen a flight to safety in the dollar. Having said that, treasuries are a poor investment as the Fed has made sure to destroy any reality in that market (and value too). Therefore it is easy to see how liquidity could move to other dollar denominated assets allowing for the strengthening dollar AND rising equities and bonds (at least here in the last few weeks). Remember, this move up in interest rates and increase in the value of the dollar is contrary to what the Fed and Treasury desire (even though they say they want a strong dollar for the sake of our Chinese buddies). The increase in rates immediately translates to greater borrowing costs for the tax payers AND devalues the value of the treasury assets we already own. The government states that it wants to keep rates low to stimulate lending, but I can also see that we need to keep rates low to keep from blowing our own foot off since we have been purchasing our own debt through quantitative easing. Zerohedge has another good post that captures exactly what I've been saying and leading up to here.

What are the results? - So we have an administration that says they want a strong dollar, but we have a Fed Chief that has stated his strategy to save the economy would rely on a devaluation of the dollar. We have had an engineered rally in all asset classes and treasury rates that are way too low for the risk and duration of the trade. In essence we have a bubble in Treasuries!
My isn't it obvious, where ever we see the footsteps of the Fed, we see bubbles? So what is on the horizon for the Fed and Treasury? In 2010 we will see greater rates as buyers decide to wait it out and purchase their mis-priced treasuries at a better risk-reward. The greater rates will hurt bond holders and most of all the US tax payer. The bond market at some point will change the behavior of our current administration and the corrupt politicians that look to hand out entitlements and lack the idea of being representatives of the people.

We will see drastic cuts in city and state budgets and services before we see anything on the Federal side, but cuts will come at the national level.

If the Fed and Treasury want to keep the charade of low rates going then a fall in the equity markets will be the mechanism to deliver lower funding rates, unless they announce a new set of Q.E.

To wrap this up, we see that in each instance the failed efforts of the government to fix the situation have either simply done nothing or helped to kick the can down the road. As we've elaborated since our first post in August, the game of extend and pretend has been in full force. The problem is that at some point (2010, 2012, or 2015....) there will not be a way to extend it and a creditor will call our bluff and call in our debts. What I am really longing for is for a responsible leader to stand up and say NO, we won't offer this entitlement, no- we are actually going to cut services. Americans are going to be forced to live through these boom and bust cycles at an increasing level of speed and magnitude because our current leadership will not speak truth. The best result of all of this crisis is that average Americans are beginning to wake up and live a paradigm based on their needs and not their wants, based on their own ability and assets, not based on what their neighbor has. I am seeing a genuine reversion to true values of healthy financial management in peoples financial lives and in their businesses. Unfortunately, they had better be ready quickly because our government is saddling them with more debt and taxation to pay for promises and entitlements we can't afford. As an example of the crisis that consumers are facing check out this closing study.

Almost half (46%) of 2,148 consumers surveyed recently said they weren’t confident they could come up with $2,000 within a month in a crisis–from savings, family, friends, credit cards or other sources.Even among those earning $100,000 to $149,000 a year. almost 25% doubted they could raise it, according to the survey conducted by research firm TNS with academics from Harvard Business School and Dartmouth College. “We wanted to know if people could fix a broken car or furnace,” says Harvard finance professor Peter Tufano, who adds that most studies he has seen measure “how much cash people have… not how much they can access.” The survey results surprised him. “The ability to cope with emergencies is much less strong than we might have thought.”

I saw this in reality as people in the South dealt with Hurricane Ike. After 1 day people were cashless and without resources to make it through this terrible emergency. Americans need to wake up and save and communicate to their leaders that it is unacceptable to continue in this fashion. We had a final emergency and the US leadership chose to fake it till they made it rather than employ real fundamental solutions to problems of our own creation. At the end of the day I feel like the Bush Administration, Obama Administration, Treasury, and the Fed have just tried to spin whatever story we would fall for in order to get us to give them time. What they have figured out is that we just want them to give us something to believe in to quote a favorite from Poison (yes, I'm still into 80's hairbands). Guess what, they've given us a few tales, let's hope that no one actually figures out that what we've believed in isn't worth the trust we've placed with them.

Goatmug