No Wonder Many Americans Are Pessimistic

No Wonder Many Americans Are Pessimistic

Courtesy of Michael Panzner at Financial Armageddon

At first glance, today’s report from the U.S. Bureau of Labor Statistics that job openings rose 2.6 percent in December from a month earlier could be seen as a positive sign for the labor market, especially considering that official jobless totals have declined for three straight months (through January).

Since the downturn began, however, the ranks of the unemployed have swelled at a far faster pace than the number of job openings. Back in December 2007, for example, there were 1.8 unemployed workers per opening; at the end of last year, the ratio was 6.1, a jump of nearly 240 percent.

This dramatic divergence suggests two things: not only are people worried about losing their jobs, they are also concerned that they will have a much harder time finding a new one than before. Given how important a paycheck is to most Americans, no wonder so many remain pessimistic about the outlook.

The Neuroeconomics Revolution

Fascinating article by Psy-Fi’s Tim.  (My yellow highlighting.) – Ilene

The Neuroeconomics Revolution

Courtesy of Tim at The Psy-Fi Blog

Marriage Made in Heaven – or Hell?

A recent development in economics sees the combining of neurology, psychology and economics in an attempt to reduce economic behaviour to brain function and to predict market behaviour from observable brain patterns. Its aim is to glue together a subject that can’t predict human behaviour from analysis of the brain with a subject that can’t predict human behaviour from analysis of people to a subject that can’t predict human behaviour from analysis of economic data.

Welcome to the Neuroeconomics Revolution.

The Busted Flushes of Psychology and Economics

Psychology spent a large part of the last century stuck in a behaviourist dead-end, carrying out endless experiments on animals in an attempt to explain all human behaviour in terms of externally observable responses to equally observable stimuli: think ringing bells causing salivating dogs or rising markets causing manic investors. The net result of this was that the subject ended up befuddled by mice running the wrong way around mazes and found itself generally regarded as the extreme paramilitary wing of the pigeon fanciers association.

Meanwhile economics, the study of how human financial systems operate, also proceeded on the basis that how humans actually behave was irrelevant and arrived at a set of explanations that defied both logic and the evidence of real markets. Yet even as economics has reluctantly faced up to the need to involve psychology in its models so psychology is beginning to recognise that understanding people requires a more detailed look at the way the brain actually works. Taken together we’re witnessing the creation of a new subject.

Neuroeconomics

Neuroeconomics is nothing more or less than the attempt to relate the now observable functioning of the brain, as provided by neuroscientific techniques, with the various models of economics. Advances in brain scanning techniques permit researchers to subject innocent participants to endless pointless questions while inspecting how their brains grapple with the problems. There is no escape.

As you might imagine, the marketeers of the world have leapt on this idea. Martin Lindstrom relates in Buyology how the inspection of people’s brains reveals what more observant marketing experts and psychologists have suspected for quite some time: asking people what their preferences are is largely a waste of time and dollars. The reason for this is quite simple – they don’t actually know, because the bits of their brains that decide whether they like something or not aren’t available for conscious inspection.

To give a single example from Lindstrom’s book, the analysis of brain processing gives the lie to the famous Pepsi taste test. In Neural Correlates of Behavioral Preferences for Culturally Familiar Drinks the researchers showed that in a blind tasting session more people preferred Pepsi over Coke despite the reverse being true when the test was unblinded. What the study of neurology showed is that the brain instinctively and initially prefers the sweeter taste of Pepsi but that emotions then kick in to overrule the initial preference in favour of Coke. Presumably this is to do with the effects of branding and other cultural preferences built over a lifetime.

Reductio Ad Absurdum

While it may seem instinctively obvious that wider economic behaviour can be reduced to individual personal behaviour and interactions and that these can be reduced to the way the brain works this is a fairly controversial idea. To start with many psychologists are opposed to such an application of reductionism, the idea that complex human behaviour can be explained by the firing of neurons and, to some extent, they’re clearly right.

For example, we know the brain is an adaptive learning machine – examples of people who’ve been born with bits of their brains missing yet have led virtually normal lives show exactly how plastic the function of the early, developing brain is. What we become is heavily dependent on what we experience. So it’s understandable that many social scientists don’t think that neurology can explain how we become what we are.

Despite this, it’s hard to argue that the developed brain doesn’t represent the way we actually are. If that’s true then neuroscience ought to be able to help us understand some of the behavioural issues that perplex psychologists. As these are often the same issues that puzzle economists from a behavioural finance perspective there seems to be a fairly simple line to be drawn from psychology to neurology.

Economic Implementation

However, many economists don’t accept that economic modelling can gain anything from neuroscience. Their argument, to simplify vastly, is that economic models are not dependent on how they’re implemented – what matters is that the models are shown to be true. Philosophers also argue in this way – so, for instance, there seems to be no restriction on consciousness being exclusively human and if it can be “implemented” on multiple different platforms – in the human brain or on complex supercomputers or in those strange energy beings dedicated to killing hapless extras in Star Trek – then there need be no direct link between the brain and advanced behaviour. You know, stuff like buying the wrong stocks at the wrong time for the wrong reason.

With which there is just the tiniest problem: this is all theoretical and until someone actually finds consciousness in something other than the human brain or its co-evolvees, it’s simply speculation. If economic systems are dependent on human behaviour and human behaviour is dependent on the way the human brain is built – which all seems rather likely – then it’s perfectly possible to make inferences from neurology to economy via psychology.

Plastic Economic Behaviour

In addition even the most recalcitrant of psychologists will concede that people’s behaviour changes depending on what they experience. So someone who endured the cataclysmic collapse of Wall Street in 1929 and suffered the grinding poverty and desperation of the Great Depression is likely to behave differently than someone brought up in the go-go Fifties or the gung-ho Nineties. Take any particular cohort of people from a specific background and subject them to the same experience then they’ll likely behave differently from other such groups.

So how likely is it that the economic models that don’t take human behaviour into account will generate realistic results? Well, of course, those models that do take human behaviour into account probably won’t do much better, but that’s because psychologists don’t yet know how to reduce human behaviour to typical neurological patterns and mechanisms.

Weirdness Personified

However, they’re working on it. By comparing brain activation on certain tasks of people with and without specific types of brain damage it’s painstakingly possible to build up a picture of what bits of the brain are engaged in what bits of processing. Researchers would prefer to stick electrodes straight into people’s brains to directly see the processing going on but this is generally frowned upon by boring ethics committees who are comprised of figures who probably reckon that they’ll be amongst the first to be plugged in and zoned out if it’s ever permitted.

So, failing this option, psychologists stick electrodes into the brains of various small animals, thus getting their revenge on those deceitful maze running mice, or use different sorts of scanners that give indirect access to human neural processing. As a result of this work we can sort of figure out which areas are involved in the various sorts of experiments that economic researchers find interesting. However, the difficulty is in interpreting these in terms of “higher behaviour” and – perhaps an even worse problem – making sure that the experiment is socially relevant. Too many psychology experiments put people into situations that are just plain weird in an attempt to control the variables: the results are invariably exciting and fascinating – and ultimately meaningless.

Monkey Business

Although all of this is still in its early days there are some interesting suggestions emerging about how various types of behaviours emerge from brain function and how these do – or don’t – map to various economic theories. Paul Glimcher, for instance, has shown that monkey neurons can appear to achieve a Nash equilibrium, basically the economically optimal algorithm for the task at hand: Glimcher’s also written an excellent overview of neuroeconomics. Meanwhile trust games are a particular favourite of investigators because these allow hypotheses to be generated based around, say, utility theory which can then be tested.

As we’ve seen before, in Stocks Aren’t Snakes, this work is suggesting that much of our seemingly irrational behaviour comes out of the new brain areas developed to support advanced human social behaviour. So while the older areas are straightforwardly selfish maximisers the newer areas will cause us to turn down offers that are in our interests because of concepts of social justice. All of which suggests that lizards might be better investors than humans. This isn’t uncontroversial, mind you: a lot of researchers think it’s poppycock.

Neuroeconomics is only likely to grow in interest to economists and marketeers alike as the technology to scan the brain and interpret its results increases: it seems to offer new ways of modelling old problems to come up with existing results. I’ll revisit this shortly to look at what, of better or worse, this may actually mean.

Related Articles: When A Dollar’s Not Just A Dollar, Stocks Aren’t Snakes, B.F. Skinner’s Stockmarket Slot Machines

 

 

Gartman: Commodities To Drop, European Union Set To Implode

Gartman: Commodities To Drop, European Union Set To Implode

Courtesy of Shocked Investor

 

Dennis Gartman says a market correction is coming and explans the benefits of sitting on the sidelines. He also says he’s shorting commodities, as prices will fall, therefore you should buy restaurants.

He does not believe the world is coming to en end, and thus is not so keen on gold.

Last but not least, he says the European Union is set to implode. Problems are structural and will last a long term. Germans remember how tough it was to bail out East Germany, they will not bailout others. He is hort Euros agains CAD and AUD.

Watch interview.

 

The Emperor Has No Clothes

The Emperor Has No Clothes

Courtesy of Chris Martenson

[Note: This is a recent Martenson Insider post that I am making public. A couple of members thought this topic deserved wider attention and conversation, and I agreed.  Thanks go to MikeP for the title change idea.] 

The NYT had an editorial this past weekend (Feb 6, 2010) that trotted out some dangerous mistruths about the deficit and framed the issue as a left vs. right political game.

I hardly know where to start, but I will note that we’ve had massive accumulations of new debts under every single administration since the early 1980s, and that it hasn’t seemed to matter which party has controlled which branches of government.  One could be forgiven for suspecting that, when it comes to deficit spending, there aren’t two parties, but only one.

The real truth is that we have a culture of reckless spending in DC that transcends either or both parties, and I always lose a bit of trust in those who attempt to paint it otherwise.  This is simply not a partisan issue.

The second objection I have to this editorial rests with its attempt to step past our deficit by painting it as self-evidently necessary (emphasis mine):

The Truth About the Deficit

When the White House released its new budget last week, including more spending to create desperately needed jobs, Republican leaders in Congress denounced President Obama for driving up the deficit and demanded that the Democrats halt their “reckless” ways.

The deficit numbers — a projected $1.3 trillion in fiscal 2011 alone — are breathtaking. What is even more breathtaking is the Republicans’ cynical refusal to acknowledge that the country would never have gotten into so deep a hole if President George W. Bush and the Republican-led Congress had not spent years slashing taxes — mainly on the wealthy — and spending with far too little restraint. Unfortunately, the problem does not stop there.

Americans should be anxious, for reasons including the huge deficit. But the cold economic truth is this: At a time of high unemployment and fragile growth, the last thing the government should do is to slash spending. That will only drive the economy into deeper trouble.

I disagree.  I happen to think that that an economic crisis is an excellent time to take a good hard look at spending habits, and, if they aren’t serving you, to slash them mercilessly.

The cold economic truth is that spending wildly beyond your means doesn’t make sense in any economic environment.  All it does is trade temporary relief today for deeper economic pain later on.

But there’s another assumption baked into this editorial that is desperately off the mark.  It is the idea that government spending is helping to lower unemployment and stabilize fragile growth, which implicitly assumes that the spending is both necessary and appropriately directed.

What if neither were actually true?

For the record, I would have an entirely different view of government spending if it were spent on different things.  For example, I am really taken by the new high speed trains (and stations) that China has received for its government expenditures:

(Source) 

Now that’s a good use of public monies!  Awesome.  I would love to see such modern investments being made in my own country.

Instead, as we gaze across the federal budget pie, it’s pretty obvious that our major expenditures have relatively little to do with long-term investments or capital improvements:

(Source)

More than half of our money is being spent on mandatory entitlement distributions, which simply means money going towards providing basic living expenses and health care.  Both are important to the recipients, but these expenditures are centered on current consumption, not long-term prosperity.

Now take a look at the remaining parts of the pie, specifically defense spending.  As enormous as that $744 billion wedge is, it understates the true extent of our security expenditures, because black-book spending and portions of the DOE, DHS, and other budgets that are dedicated to defense activities are hidden over there in the "Nondefense" pie wedge.

Some estimates suggest that our yearly defense outlays now approach $1 trillion.

Let’s put that in context.  Here are the projected revenues for the 2011 fiscal year:

(Source)

If we divide defense spending of $744 billion by projected individual income taxes ($1,121 billion), we find that 66%, two-thirds (!) of all such receipts, are consumed by defense spending.

It pretty much goes without saying that a nation cannot be prosperous in the long run if it is spending two-thirds of its individual income tax receipts on defense expenditures.

Of course, we’ve managed to hide this over the years by going deeper and deeper into debt, so most people are not directly aware that two-thirds of their April 15th contributions are mainly headed either overseas or into the coffers of defense contractors.

Only 17% of our entire 2011 budget is going to go to nondefense spending, and the lion’s share of that is for programs and hires that are already in motion or in place.

84% of all receipts are going to go towards mandatory spending in 2011.  Let that sink in for a moment.  84%.  Let me type that slowly:  e.i.g.h.t.y. f.o.u.r. p.e.r.c.e.n.t. 

And 94% of all revenues are entirely consumed by mandatory spending plus the interest payments (also arguably "mandatory").  So no matter how much politicians say they want to "cut spending’, rest assured that they have backed themselves into a very sharp corner.  There’s no maneuvering room left.

In FY 2011 expenditures are slated to exceed revenues by 49%.  Forty-nine percent.  49% (!).  Okay, now I am scaring myself.

Now matter how you slice these expenditures, they are unsustainable.

Think of how intense the future budget battles would be if the government had to live within its means.  Imagine if each wedge of the budget had to be shrunk by a third to bring expenditures in line with revenues.  Politically, I just can’t see this happening, which is why I continue to believe that every effort will be made to print our way out of the problem.

As a side note, I somehow missed this article from Friday, notable because it is the first public trial balloon that I’ve seen floating the idea that the Fed might not stop its thin-air money-printing program:

Official says Fed might buy more mortgage-backed securities

Friday, February 5, 2010

The Federal Reserve would consider reopening its program to support the mortgage market if interest rates spiked or the economy showed new weakness, Federal Reserve Bank of New York President William C. Dudley said in two new interviews.

Remember, I thought that the end of March would be the time when we would get our read on whether the program would involve renewed efforts at borrowing and printing our way out of our easy-money debt pile-up.  Looks like we’re right on track.

Now, back to the editorial.

The idea that there’s no room to cut government expenditures without seriously impacting the economy is pure bunk.  We could easily trim defense spending without impacting our economy in the slightest, if we chose to reduce the amount of money we are sending overseas to maintain 700+ foreign military bases and prosecute two wars.

Next, we might also imagine that if we diverted money being spent on military expenditures into, say, high speed trains, wind farms, natural gas pipelines and distribution stations, and an upgraded electrical smart grid (for example), we’d get far more immediate and lasting economic benefit (and improved national security too, I might point out) than we would out of so-called "defense spending."

The cold economic truth is that we are slowly bankrupting our country.  And we are spending our money on things that do not contribute to our collective long-term prosperity.

Instead, I wish that this editorial, and dozens of others like it in other newspapers, would take a deep breath and ask the deeper and harder questions about our national priorities, challenges, and opportunities, and then call for a significant departure from the business-as-usual budget fiasco that is slowly but steadily leading us towards a vastly diminished future.

In short, somebody has to say it:  The emperor has no clothes.

Until we can have a legitimate discussion about the true economic costs and opportunities lost associated with our current expenditure regime, I do not see much hope that we’ll magically navigate ourselves to a better, more prosperous future.

That’s the real truth about the deficit.

 

RYDEX MARKET TIMERS ARE BECOMING MORE BEARISH

RYDEX MARKET TIMERS ARE BECOMING MORE BEARISH

Courtesy of The Pragmatic Capitalist

The following comes to us courtesy of The Technical Take:

Figure 1 is a daily chart of the S&P500. The indicator in the lower panel measures the ratio of the amount of assets in the Rydex bullish and leveraged funds relative to those funds that are bearish and leveraged.

Figure 1. S&P500/ daily/ Rydex Bullish and Leveraged v. Bearish and Leveraged

The current value of the indicator stands at 1.02 suggesting that the Rydex market timers are becoming more bearish, and this is a bullish signal.

How bullish? Let’s design a study with the following rules:

1) entry signal: when the ratio of the Rydex bullish and leveraged assets to the Rydex bearish and leveraged assets is less than or equal to 1 and when the S&P500 is above its 200 day moving average

2) exit signal: when the ratio of the Rydex bullish and leveraged assets to the Rydex bearish and leveraged assets is greater than 1

3) all trade signals are executed at the open of the day following the signal as this mimics exactly how I receive the Rydex data (i.e., the night before)

4) commissions and slippage are not considered.

Of note, some of the buy and sell signals are shown in figure 1.

The strategy was back tested on the S&P500 with the first trade beginning on April 15, 2003. This strategy generated 529 S&P500 points; since April 15, 2003, buy and hold has generated 170 S&P500 points. There were 35 trades, and 31 of these were profitable. This strategy had a streak of 19 consecutive winning trades. Amazingly, this strategy was only in the market 7% of the time over the past 7 years. The average winning trade lasted 6 trading days with the average loser lasting 3 trading days. There was only one outlier trade which accounted for about 10% of the profits, and the profit factor (i.e., gross profit to gross loss) was a sizzling 23 to 1.

The equity curve for the strategy is shown in figure 2.

Figure 2. Equity Curve

 

 

Figure 3 is a the maximum adverse excursion graph (MAE) for this strategy. MAE assesses each trade from the strategy and determines how much a trade had to lose in percentage terms before being closed out for a winner or loser. You put on a trade and if you are like most traders, the position will move against you. MAE measures how much you have to angst and squirm while you are in that position. Because once you close the position out for a loss or a win, you are done worrying about it. As an example, look at the caret in figure 3 with the blue box around it. This one trade lost 2% (x-axis) before being closed out as a 1% loser (y-axis). We know this was a losing trade because it is a red caret.

 

Figure 3. MAE Graph 

Now look to the right of the blue line. There were only 3 trades that had an MAE greater than 1.6%. Or to put it another way, greater than 90% of the trades from this strategy never lost more than 1.6%.

Holy grail? Kind of sounds like it. So let’s remember the following:

1) The current ratio of the Rydex bullish and leveraged to bearish and leveraged is still above 1; I have not tested for the optimal ratio to implement this strategy, but one more bearish day is likely to embolden the Rydex bears even more and push this ratio to less than 1.

2) I have selected the “best” trades by utilizing the 200 day moving average as a filter.

3) The start date of the back test coincides with the start of the 2003 bull market, when there are still many non-believers (i.e., bears). This may have skewed the results.

4) Once again, we should remember this is a very short term trading strategy and it does not say anything about the intermediate term direction of the market.

5) I always caution that what has worked in the past doesn’t always work in the present. The probabilities are high that the outcome should be positive (i.e., the expectancy) but this doesn’t guarantee a positive outcome. The logic (i.e., going against the consensus) behind the strategy is sound, and the logic works across multiple markets and time frames. The filter (i.e., taking only those trades above the 200 day moving average) is reasonable, and the strategy is easy to execute. These are all good features that I look for in a trading strategy.

Lastly, the current value of the ratio is 1.02; this strategy was tested using a threshold value of 1. Is there any difference between 1.02 and 1? Probably not, but I don’t know. I remember 20 years ago taking my oral examinations for specialty certification in anesthesiology. The exam proctors always get to the question that requires some degree of judgment. For example, medical studies use to show that if a patient had a heart attack within 6 months of a surgery they were at high risk for having another heart attack during surgery. So the scenario always comes up: you have a patient scheduled for surgery and she tells you that she had a heart attack 5 months and 29 days ago, and the examiners want to know if you will cancel surgery. As it turns out, the correct answer isn’t being dogmatic by standing behind some medical study. You could quote that famous study and you would be right, but that would always invite the examiners to say, “o.k., the patient really had a heart attack 6 months and 1 day ago…..so, now what are you going to do?” Now you have to say, “yes, I will do the case,” yet nothing has really changed. As it turns out, the right answer is to say that I will assess the patient and find out what kind of heart attack she had, how she has done over the past 6 months (i.e., she could be out playing golf everyday without cardiac problems), and what type of surgery she is having (i.e., removal of a bunion under local is a lot different than an abdominal hysterectomy under general). It’s o.k. to quote the medical study, but just don’t become wedded to it.

1.02? 1.0? I don’t have an answer for you. I have presented a study. You have to use your judgment.

 

The Audacity Of Synthetics

Karl Denninger discusses an article posted here several weeks ago, John Paulson and the Greatest Pump and Short Fraud Ever, by Mark Mitchell at Deep Capture. - Ilene 

The Audacity Of Synthetics

Courtesy of Karl Denninger, The Market Ticker

DeepCapture has picked up something I’ve written about before, but none of these folks seem to put together the "big picture", as I outlined yesterday on my Blogtalk show.

As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.

Let’s step back a second.

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument.  It is, at it’s core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

The usual thought process when someone says "CDO" is that some bank bought a bunch of bonds, compiled them into a CDO and then sold off the tranches.

The CDO itself is typically held off-balance sheet in a SIV/SPV, lest the bank be forced to recognize it as part of it’s "assets."  This is permissible because the bank doesn’t own the assets, the legal entity does, and it got the money to buy them from the people who bought the tranches that were issued.  The banks do this because they get a nice fee for filing the papers to establish the entity along with a management fee to act as the servicer – that is, the "guy in the middle" who takes the money that comes in from the debt instruments and slices it up, paying out those funds to the buyers of the CDO’s tranches.

So you can think of a CDO, in it’s simplest form, as a way of taking a bunch of bonds, putting them together, and then deciding by some mathematical formula who gets the lion’s share of the risk in those bonds, along with (of course) the larger set of the rewards.

But of course in "structured finance" nothing is ever as simple as it seems.

Remember what I said up above?

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument.  It is, at it’s core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

Who said that the "assets" had to be actual bonds?

A synthetic CDO is, as the name implies, not made up of actual bonds.  Instead, the issuer writes a naked credit-default swap on the underlying reference(s) they use.

The buyer of that CDS pays a premium, usually in the form of an annual payment (and sometimes something up front too.)

BINGO!  We have "a thing" that throws off an income stream and thus can, and does, form the basis for a CDO!

The "CDOs" that are at issue here were synthetics.

That is, they did not own actual bonds, they were comprised of credit-default swaps that Goldman wrote against subprime mortgage bonds.

This would have left Goldman exposed (as the writer of the swaps) for the potential losses.  Goldman, in turn, bought a CDS from AIG against the "portfolio" in the CDO, thereby laying off the risk on AIG.

Goldman is thus now "net neutral" (provided AIG can pay!) and happy as a pig in slop, as they made money on the origination fees for the CDO and in addition get to skim a nice little bit off the servicing. 

What could possibly go wrong?

More than a few things.

Let’s start with how this CDO got funded.  Remember, it got originated by Goldman writing a bunch of credit-default swaps.  Who bought them?  Someone had to think subprime was going to detonate, because they paid good money for "protection" that would go up dramatically in value if it did, but for which they were going to pay the CDO investors good money if it did not.

It appears that the buyer of those credit-default swaps was, perhaps, John Paulson:

“Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking.”

Ah, so the allegation contained here is that John Paulson (of hedge fund fame, not to be confused with Hank Paulson the ex-treasury secretary) combed through the pile of subprime mortgage bonds that were out there and handed Goldman a list of "what I want in there", then offered to buy the Credit Default Swaps that would pay out at a huge multiple if and only if those underlying bonds failed to perform.

In other words Paulson combed through the data available on these subprime mortgage deals and picked out the crappiest of the garbage – the most-rotting of the dead fish, all of which allegedly were "AAA" at the time one would presume but which he was quite sure would soon be either downgraded - or default outright - and then asked Goldman to use those as the references against which it would write the swaps that Paulson wanted to buy.

But remember – Goldman didn’t buy the bonds to set up the CDO – they just issued a credit-default swap, which, it appears, Paulson’s hedge fund bought.

Goldman then went out and solicited people to buy the tranches of the CDOs, selling what was alleged to be a cash-flow stream that Mr. Hedgie had offered (out of the goodness of his heart, no doubt – ed: yes, that’s sarcasm) to fund!

Here’s the question:

Did Goldman disclose to the potential buyers in the offering circular that John Paulson had come to them with a laundry list of characteristics he wanted in the CDO and offered to fund the credit-default swaps which would only make him money if those reference bonds blew up, and that he would take large, material losses IF THE SECURITIES – AND THE CDO – PERFORMED AND ACTUALLY GENERATED THE CASH FLOWS PROMISED?

I don’t have a copy of the offering circulars for these CDOs.  Perhaps someone does and can forward them to me. 

But somehow I find it hard to believe that it was made clear to the buyers of these tranches before they plunked down their money that they came into existence because a wise guy came to the bank and asked for them to create a synthetic CDO with specific characteristics and that they would provide the cash flow to be paid to their investors - but that the essence of their desire in setting this up was that they believed the reference instruments would default and in doing so they would become rich while the tranche buyers would be left with little or nothing!

You can say that the buyers of the CDOs should have done their due diligence.  Ok, I’ll grant you that.  You can also say that the ratings agencies had no business granting "AAA" ratings on underlying securities with such shaky repayment prospects, and I’ll agree with that too.

But this leaves open the question of whether it is fair, just, or even legal to create a synthetic security that at it’s core comes into existence because someone believes that the reference is going to detonate, and then sell off pieces of that security to investors without prominently disclosing the source of the funding of the cash flow, that they proffered the criteria for inclusion in the reference and that the INTENT of their funding was to profit from an EXPECTED detonation of the reference securities.

It also leaves open the question of laying off that risk on an insurance company (whether in a regulated subsidiary or not) without similarly disclosing the above to them up front!  That is, is it fair, just (or even legal) to buy fire insurance on a property when you have been told that someone expects a fire in that structure based on what they believe is credible analysis (e.g. a look at the wiring plan), without telling the insurance company about what you were told?

I don’t have answers to the questions about the propriety or legality of these actions.  But I can opine on my view of the ethics involved in such a set of transactions by a bank, and that’s easy: this, in my opinion, is nothing more or less than intentionally screwing people.  That is, this is not about "intermediation" or any such claptrap – it was, in my opinion, a pure act of financial rape-for-profit.

These sorts of "naked" positions – whether in the form of a raw naked Credit Default Swap or in the form of a "synthetic" CDO – must be barred for creation, trading, management and handling in all of their forms by any entity subject to any form of federal or state regulation or backstop, including but not limited to banks, insurance companies, pension funds and similar entities.

If hedge funds wish to bet amongst themselves on the life (or death) prospects for a given reference security, let them do so.  I don’t care one whit if John Paulson is right or wrong – he’s entitled to place his bets and make (or lose) money as fate and skill dictate.

But he should not be entitled to solicit a bank, investment or otherwise, to peddle off securities to others and obtain what amounts to insurance on their performance, while not fully disclosing to everyone involved that THE VERY REASON THIS SECURITY EXISTS is that he wanted to place a bet that the reference on which this security was based would detonate, and that if he is correct in his analysis THOSE WHO BUY AND INSURE THIS "SECURITY" WILL FIND THEMSELVES HOLDING A PILE OF USED TOILET PAPER.

 

An Insider’s View of the Real Estate Train Wreck

An Insider’s View of the Real Estate Train Wreck

By David Galland, The Casey Report

The first time I spoke with real estate entrepreneur Andy Miller was in late 2007, when I asked him to serve on the faculty of a Casey Research Summit. As John Mauldin, a former faculty member himself, knows, we’re very selective with our speakers. And there was no one in the nation I wanted more than Andy to address the critical topic of real estate.

My interest in Andy was due to the fact that he has been singularly successful in pretty much all aspects of the real estate market, including financing and developing large projects – such as shopping centers, apartment communities, office buildings, and warehouses – from one end of the country to the other. His expertise has also allowed him to build an impressive business providing assistance to large financial institutions that need help in dealing with problem commercial real estate loans. As you might suspect, business is booming.

Back in 2007, however, what most intrigued me about Andy was that he had been almost alone among his peer group in foreseeing the coming end of the real estate bubble, and in liquidating essentially all of his considerable portfolio of projects near the top. There are people that think they know what’s going on, and those who actually know – Andy very much belongs in the latter category.

In fact, he initially refused to speak at our event, only agreeing very reluctantly after I had hounded him for several months. The reason for his refusal, I later found out, was that he had spoken at several industry events before the real estate collapse and had been all but booed off the stage for his dire outlook.

The happy ending of this story is that Andy’s speech at our Summit was a rousing success, and he enjoyed it so much that he has now spoken at several, and has kindly agreed to sit for periodic interviews to keep our readers up to date on the latest developments in this critical sector. So far, Andy’s real estate forecasts continue to come true. 

As you’ll read in the following excerpt from my latest interview with Andy, who now spends considerable time each day helping the nation’s biggest banks cope with growing stacks of problem loans, he remains deeply concerned about the outlook for real estate.

David Galland

No one has been more right on the housing market in recent years. So, what’s coming next? Some of the housing numbers in the last few months look a little less ugly. Could housing be getting ready to get well?

MILLER: I don’t think so.

For all intents and purposes, the United States home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the U.S. were made with federal assistance, either through Fannie Mae and the implied guarantee, or Freddie Mac, or through the FHA.

If it’s true that most of the financing in the single-family home market is being facilitated by government guarantees, that should make everybody very, very concerned. If government support goes away, and it will go away, where will that leave the home market? It leaves you with a catastrophe, because private lenders for single-family homes are nervous. Lenders that are still lending are reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage. So when the supply of government-facilitated loans dries up, it’s going to put the home market in a very, very bad place. 

Why am I so certain that the federal government will have to cut back on its lending? Because most of the financing is done via the bond market, through Ginnie Mae or other government agencies. And the numbers are so big that eventually the bond market is going to gag on the government-sponsored paper.

The public doesn’t have any idea of the scale of the guarantees the government is taking on through Fannie, Freddie, and FHA. It’s huge. If people understood what the federal government has done and subjected the taxpayers to, there would be a public outrage. But you can’t get people to focus on it, and it’s very esoteric, it’s very hard to understand. But it’s not something the bond market won’t notice. The government can’t keep doing what it has been doing to support mortgage lending without pushing interest rates way up.

Refinancings of single-family homes are very interest-rate sensitive. Consumers have their backs against the wall. They have too much debt. Refinancing their maturing mortgages or their adjustable-rate mortgages is very problematic if rates go up, but that’s exactly where they’re headed. So anyone who’s comforted by current statistics on single-family homes should look beyond the data and into the dynamics of the market. What they’ll find is very alarming.   

On that topic, recent data I saw was that something like 24% of the loans FHA backed in 2007 are now in default, and for those generated in 2008, 20% are in default, and the FHA is out of money.

MILLER: Fannie Mae had a $19 billion loss for the third quarter of 2009, and they are now drawing on their facility with the U.S. Treasury. We have all forgotten that Fannie and Freddie are still being operated under a federal conservatorship. On Christmas Eve, the agency announced that they were going to remove all the caps on the agencies.

So what about commercial real estate?

MILLER: When I saw what was happening in the housing market, I liquidated all my multifamily apartments, shopping centers, and office buildings. I liquidated all my loan portfolios, and I’m happy I did.

Then it occurred to me in 2005 and 2006 that the commercial world had to follow suit. Why? Because it’s a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value. And when consumers hit the wall with spending and debt, that’s going to have an impact on retailers that pay for commercial space.

Furthermore, the financing for retail properties had gotten ludicrous. The conduits were making loans that they advertised as 80% of property value when they originated them, but in reality the loan-to-value ratios were well over 100%. And I say that to you with absolute, categorical certainty, because I was a seller and nobody knew the value of the properties that I was selling better than I did. I had operated some of them for 20 years, so I knew exactly what they were bringing in. I knew what the operating expenses were, and I knew what the cap rates were. And, you know, the underwriting on the loan side and the purchasing side of these assets was completely insane. It was ludicrous. It did not reflect at all what the conduits thought they were doing. They were valuing the properties way too aggressively.

I became very bearish about the commercial business starting in late ‘05. In fact, I think I was in Argentina with Doug Casey, sitting on a veranda at one of the estancias, and he and I were lamenting what was going on in the real estate business, and I said there was going to be a huge adjustment in the commercial market.

Beyond the obvious, that the real estate market has taken pretty significant hits and some banks have been dragged under by their bad loans, what has really changed in real estate since the crash? 

MILLER: I think the first thing that changed was that people learned that prices don’t go up forever. Lenders also saw that underwriting guidelines for commercial real estate loans, especially in the securitization markets, were erroneous. They realized that some of their properties had been financed too aggressively, but still, I don’t think even at the fall of Lehman, anybody was predicting a wholesale collapse in commercial real estate.

But they did see they should be more circumspect with loan underwritings. In fact, after the fall of Lehman, they completely stopped lending. I think they realized we had been living in fantasy land for 10 years. And that was the first change – a mental adjustment from Alice in Wonderland to reality. 

Today it’s clear that commercial properties are not performing and that values have gone down, although I’ve got to tell you, the denial is still widespread, particularly in the United States and on the part of lenders sitting on and servicing all these real estate portfolios. People still do not understand how grave this is.

Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you’ve been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?

MILLER: It’s an educated guess, and it hasn’t changed. I still think that it’s second quarter 2010.

The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there’s some alternative in place, it’s going to be a very hideous picture for the bond market and the banking system.

The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well – not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I’ll give you an example.

In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn’t have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.

That’s very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they’ll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that’s horribly destructive.

Just to be clear on this, let’s say I own an apartment building and I’ve been making my payments, but I’m having trouble and the value of the property has fallen by half. I go to the bank and say, "Look, I’ve got a problem," and the bank says, "Okay, let’s work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we’ll shake hands and smile." Then, even though the property’s value has dropped, as long as we keep smiling and I’m still making payments, then the bank won’t have to reserve anything against the risk that I’ll give the building back and it will be worth a whole lot less than the mortgage.

MILLER: I think what you just described is accurate. And it’s exactly a Japanese-style solution. This is what Japan did in ‘89 and ‘90 because they didn’t want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses. 

And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it’s not going to sell them. 

Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.

Wouldn’t banks know that ultimately the piper must be paid, and so they’d be trying to build cash – trying to build capital to deal with the problem when it comes home to roost?

MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it’s digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it’s going to be. I can tell you that because I’m out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices – all the foot-dragging allows the fundamental problem to get worse. 

In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you’re clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?

Or a borrower who is sitting on a suburban office property – he’s got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don’t think so. So the problems get bigger.

Why would the owner bother going through a workout with the bank if he knows he’s so deep underwater he’s below snorkel depth?

MILLER: It’s always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you’re a borrower who’s guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there’s always a little hope that values will turn around. So there is no reason to hurry into a default. None.

So that’s from the borrower’s standpoint. But wouldn’t the banks want to clear these loans off their balance sheets? 

MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone. 

So here we are, we’ve got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They’ve taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?

MILLER: Well, obviously nobody knows, but I can guess at what’s coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.

I think they’re going to contrive something to help assist commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. It’ll resemble what they did with housing.

They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire U.S. residential mortgage market has in effect been nationalized, but there wasn’t any act of Congress, no screaming and shouting, no headlines in the Wall Street Journal or the New York Times about "Should we nationalize the home loan market in America." No. It happened right under our noses and with no hue and cry. That’s a template for what they could do with the commercial loan market. 

And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.

But it won’t really be a solution. In fact, it will make the problems much more intense. 

Don’t these properties have to be allowed to go to their intrinsic value before the market can start working again?

MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We’re going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem. 

Do you think the U.S. will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?

MILLER: I know this is going to make you laugh, but I’m actually an optimist about this. I’m not optimistic about the short run, and I’m not optimistic about the severity of the problem, but I’m totally optimistic as it relates to the United States of America.

This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.

 

Andy Miller is the co-founder of the Miller Frishman Group (www.millerfrishman.com), which includes three companies serving different sectors of the real estate market – from mortgage brokerage and banking, to the building, management, and marketing of commercial real estate across the United States. His firm is currently deeply involved in the distressed real estate business, assisting lenders across the nation with their growing portfolios of non-performing loans.

 

Real estate crashing, unemployment rising, sky-high government debt – is there any silver lining in all of this? There is, and the editors of The Casey Report are pros in locating it. Analyzing tomorrow’s mega-trends and finding the best opportunities to profit from them is what they do. Learn how these expert trend hunters can help you make money even in the toughest crisis… click here.

 

 

Citizens United Case

Note: I wrote about this before and have since added a bit of analysis and an article by George Washington of Washington’s Blog.

Citizens United Case – Corporate Campaign Contributions

By Ilene

I’m a strong supporter of First Amendment rights, but my perspective on this case is that it is not only a First Amendment case but also should have been considered as a Fourteenth Amendment case.

First Amendment:

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

Should corporations and unions have all the constitutional protections that individual ”natural” persons (i.e. you and me) have when it comes to First Amendment rights? How about “associations” of people? Are all associations equal? I don’t think so.

Justice Scalia wrote in his concurring opinion:

It is the speech of many individual Americans, who have associated in a common cause, giving the leadership of the party the right to speak on their behalf. The association of individuals in a business corporation is no different—or at least it cannot be denied the right to speak on the simplistic ground that it is not “an individual American.”

I disagree that political parties and corporations should be treated similarly. Members of a political party are engaged due to their political beliefs and free choice of association, whereas corporations do not speak for all persons associated with the corporation such that all members (shareholders, management, employees) are freely and voluntarily choosing to fund of the corporate political message.

As Justice Stevens wrote in his dissenting opinion in the Supreme’s Court ruling in the Citizens United case:

Corporations are not actually members of [our society]. They cannot vote or run for office. Because they may be managed and controlled by nonresidents, their interests may conflict in fundamental respects with the interests of eligible voters. The financial resources, legal structure, and instrumental orientation of corporations raise legitimate concerns about their role in the electoral process. Our lawmakers have a compelling constitutional basis, if not also a democratic duty, to take measures designed to guard against the potentially deleterious effects of corporate spending in local and national races.

Abraham Lincoln may have seen the writing on the wall years ago:

We may congratulate ourselves that this cruel war is nearing its end. It has cost a vast amount of treasure and blood. . . . It has indeed been a trying hour for the Republic; but I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. As a result of the war, corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed. I feel at this moment more anxiety for the safety of my country than ever before, even in the midst of war. God grant that my suspicions may prove groundless. [my emphasis]

The passage appears in a letter from Abraham Lincoln to (Col.) William F. Elkins, Nov. 21, 1864.

Legal Background

“County of Santa Clara vs. Southern Pacific Railroad” was perhaps the worst U.S. Court Decision, not for its actual decision, but for its signficance based on an unargued, undecided issue. 

Santa Clara County v. Southern Pacific Railroad Company, 118 U.S. 394 (1886) was a United States Supreme Court case dealing with taxation of railroad properties. The case is most notable for the obiter dictum statement that juristic persons* are entitled to protection under the Fourteenth Amendment.”…

Fourteenth Amendment (relevant section):

Section 1.
All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside. No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

Whether or not protections under the Fourteenth Amendment were intended by the Supreme Court to be extended, and to be extended fully, to corporations was never actually decided by the justices. Santa Clara was a tax law case. The statement conferring Fourteenth Amendment protections to corporations was written by the court reporter, J.C. Bancroft Davis, as part of a headnote (introductory summary of the case): 

“The court does not wish to hear argument on the question whether the provision in the Fourteenth Amendment to the Constitution, which forbids a State to deny to any person within its jurisdiction the equal protection of the laws, applies to these corporations. We are all of the opinion that it does.”

Thus, the extent to which corporations are entitled to legal protections under the Fourteenth Amendment was not discussed in the context of a question before the Court at the time – and hence would not usually be considered controlling and settled law.  

Later, Chief Justice Morrison Waite responded to Davis’s inquiry regarding the accuracy of his headnote:

I think your mem. in the California Railroad Tax cases expresses with sufficient accuracy what was said before the argument began. I leave it with you to determine whether anything need be said about it in the report inasmuch as we avoided meeting the constitutional question in the decision.

According to the Wikipedia article:  

C. Peter Magrath, who discovered the exchange while researching Morrison C. Waite: The Triumph of Character, writes “In other words, to the Reporter fell the decision which enshrined the declaration in the United States Reports…had Davis left it out, Santa Clara County v. Southern Pac[ific] R[ailroad] Co. would have been lost to history among thousands of uninteresting tax cases.”

Author Jack Beatty wrote about the lingering questions as to how the reporter’s note reflected a quotation that was absent from the opinion itself.

“Why did the chief justice issue his dictum? Why did he leave it up to Davis to include it in the headnotes? After Waite told him that the Court ‘avoided’ the issue of corporate personhood, why did Davis include it? Why, indeed, did he begin his headnote with it? The opinion made plain that the Court did not decide the corporate personality issue and the subsidiary equal protection issue.”

In view of the back-door way in which Fourteenth Amendment equal protection for Corporations has entered into case law, perhaps this protection has been given more weight than deserved. It seems perverse to me that protections conferred by the Constitution and Fourteenth Amendment should be extended to natural persons and corporations equally, without heated argument and debate before the Supreme Court.

From the Wikipedia article: 

Not being part of the court’s opinion, the “person” observation did not technically in the view of most legal historians have any legal precedential value…

Justice Hugo Black wrote “in 1886, this Court in the case of Santa Clara County v. Southern Pacific Railroad, decided for the first time that the word ‘person’ in the amendment did in some instances include corporations…The history of the amendment proves that the people were told that its purpose was to protect weak and helpless human beings and were not told that it was intended to remove corporations in any fashion from the control of state governments…The language of the amendment itself does not support the theory that it was passed for the benefit of corporations.”

Justice William O. Douglas wrote in 1949, “the Santa Clara case becomes one of the most momentous of all our decisions.. Corporations were now armed with constitutional prerogatives.”

Flash forward: In regards to the Supreme’s Court ruling in the Citizens United case Jeremy Grantham writes in “Stop the Presses!” on the GMO site on January 21, 2010:

… and the Bad News Supremely Extreme: Another “Day That Will Live in Infamy”

Five Supreme Court justices today announced that not only are corporations people and that their money is free speech – this is old hat and a very ugly hat at that – but now, there should be no limit to the money they spend to influence political outcomes. This would be one thing if corporations really were “democratic associations” of humans that the Founding Fathers may have wanted to protect. They are, instead, small oligarchies of top management. Thus, the top management of major oil and coal companies can decide what political outcomes they want to promote, say, unlimited production of carbon dioxide (none of their CEOs apparently has grandchildren!), utterly without any approval of their decisions by the millions of actual owners. The financial power of corporations was already in danger of overwhelming the democratic process in Congress and this makes the damage potentially unlimited and puts the Court’s seal of approval on it. So let’s do it in style and have a name change. The U.C.A. has a familiar look: The United Corporations of America!

*****

Kevin Drum in Mother Jones provides a thoughtful analyses of the Court ruling in the Citizens United case in the following article:

Money in Politics

I’m just enough of a First Amendment fundamentalist to believe that there are plausible arguments for allowing corporations to make political contributions; just enough of a realist to think that it might not make as much difference as a lot of people think; and just enough of a cynic to think that corporations might not be as eager to spend huge pots of political money in plain view of their customers as you might suppose. On the other hand, I’m not credulous enough to think that modern multinational corporations are mere voluntary assemblies of concerned citizens who deserve to be treated the same way as the local PTA. The world is what it is, and in a practical sense corporations have such enormous power that it would be foolhardy in the extreme to think that we can just blindly provide them with the same rights as individuals and then let the chips fall where they may.

In the end, I guess I think the court missed the obvious — and right — decision: recognizing that while nonprofit corporations created for the purpose of political advocacy can be fairly described as “organized groups of people” and treated as such, that doesn’t require us to be willfully oblivious to the fact that big public companies are far more than that and can be treated differently. Exxon is not the Audubon Society and Google is not the NRA. There’s no reason we have to pretend otherwise.

Full article here.>> 

*****

George Washington of Washington’s Blog wrote the following article expressing his opinion on the matter.

Supreme Court Ruling Guts Campaign Finance Law, “Threatens to Undermine the Integrity of Elected Institutions Around the Nation” 

Courtesy of Washington’s Blog

The long-awaited Supreme Court decision striking down most campaign finance laws – Citizens United v. Federal Election Commission – happened today.

One of the dissenting Supreme Court Justices, John Paul Stevens, wrote:

The court’s ruling threatens to undermine the integrity of elected institutions around the nation.

Stevens also said that the court reached to expand beyond the scope of the case. In other words, the court acted for political reasons, not judicial reasons:

Essentially, five justices were unhappy with the limited nature of the case before us, so they changed the case to give themselves an opportunity to change the law.

This is a gigantic change, and you will see mammoth corporations – including the giant banks who have received trillions in taxpayer-funded bailouts, guarantees and other perks – inundating the airwaves with campaign blitzes to make sure that “loyal” politicians are elected.

Just watch: money which was taken from our pockets to “bail out” the too big to fails will be used to make sure that tame corporate mouthpieces are put into office.

Note: The decision also allows unions to go wild with buying campaign ads. But given that the too big to fails have unlimited access to the spigot of funds at the public trough, they will be able to outspend unions by many orders of magnitude.

Yes, I know that the giant banks have already bought and paid for Congress and the White House. See this, this and this. The Citizens United decision will just make it cheaper and easier to buy elections.

For other horrible recent Supreme Court decisions, see this and this.

*****

A “juristic person” is a legal fiction through which the law allows a group of natural persons to act as if it were a single composite individual for certain purposes. The most common purposes are lawsuits, property ownership, and contracts. The concept goes by many names, including corporate personhood. A juristic person is sometimes called a legal person, artificial person, or legal entity (although the last term is sometimes understood to include natural persons as well). Statemaster.com

Photo source here.

Another Day, Another Bail-Out

Another Day, Another Bail-Out

Courtesy of John Rubino at Dollar Collapse

With a bail-out of Greece apparently imminent and everyone drawing parallels between the PIGS countries and the Wall Street firms that nearly cratered the global economy in 2008, this might be a good time to ask why each year seems to bring a new set of financial basket cases requiring taxpayer cash.

The answer, of course, is easy money. When governments create too much credit, borrowing gets easier at the margins and the less intelligent, moral, and wise end up borrowing far more than they would normally be able to. When they inevitably implode, the world gets another chance to behave rationally by letting them go, accepting the resulting short-term pain, and learning the relevant lessons. But beginning in the 1990s with the Mexican and Russian defaults and the self-destruction of Long Term Capital Management, the strong economies have chosen to avoid the pain and bail out the losers.

This lack of adult supervision produces two results:

First, the credit created by each new bail-out finds its way into other weak hands, further impairing their balance sheets and requiring more bail-outs. Now we’ve graduated from banks to governments, and apparently a borrower as inconsequential as Greece (with foreign debt of less than $400 billion) can bring down the entire global financial system.

Second, the balance sheets of the strong countries get progressively weaker. As the U.S. took on Fannie and Freddie’s trillions, so will Germany absorb Greece’s billions. And the new wave is just getting started. Greece is the worst case, but just barely. Portugal, Spain, California and Illinois all owe more than they can ever hope to pay, and will, by the current standard of everything being too big to fail, have to be bailed out in the coming year. Their debts won’t be wiped out, but will migrate to Germany, France, or Washington. At some point those countries’ rock-solid bond ratings, already fictitious, will start to drop, making future bail-outs both harder and more necessary.

So 2010 will be the year of sovereign bail-outs at the periphery, which is bad enough. But next year, once several trillion more dollars and euros have been loaded onto large country balance sheets, the bailout profile will ratchet up to the next level, with one of the superpowers finding it impossible to roll over its debt. Japan looks like the best first-domino bet at this point, but as someone said not long ago, every debt auction is now an event risk. So it could easily be the U.S. which sees Treasury demand evaporate, followed by a spike in rates and a plunging dollar.

Putting it another way, bail-outs require strong currencies. As long as someone can borrow enough to defuse the latest time bomb the party will go on. When the bond or currency markets say no more, the party will end. Then we’ll see who’s really too big to fail.

 

The Audacity Of Synthetics

Karl Denninger discusses an article posted here several weeks ago, John Paulson and the Greatest Pump and Short Fraud Ever, by Mark Mitchell at Deep Capture.  

The Audacity Of Synthetics

Courtesy of Karl Denninger, The Market Ticker

DeepCapture has picked up something I’ve written about before, but none of these folks seem to put together the "big picture", as I outlined yesterday on my Blogtalk show.

As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.

Let’s step back a second.

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument.  It is, at it’s core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

The usual thought process when someone says "CDO" is that some bank bought a bunch of bonds, compiled them into a CDO and then sold off the tranches.

The CDO itself is typically held off-balance sheet in a SIV/SPV, lest the bank be forced to recognize it as part of it’s "assets."  This is permissible because the bank doesn’t own the assets, the legal entity does, and it got the money to buy them from the people who bought the tranches that were issued.  The banks do this because they get a nice fee for filing the papers to establish the entity along with a management fee to act as the servicer – that is, the "guy in the middle" who takes the money that comes in from the debt instruments and slices it up, paying out those funds to the buyers of the CDO’s tranches.

So you can think of a CDO, in it’s simplest form, as a way of taking a bunch of bonds, putting them together, and then deciding by some mathematical formula who gets the lion’s share of the risk in those bonds, along with (of course) the larger set of the rewards.

But of course in "structured finance" nothing is ever as simple as it seems.

Remember what I said up above?

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument.  It is, at it’s core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

Who said that the "assets" had to be actual bonds?

A synthetic CDO is, as the name implies, not made up of actual bonds.  Instead, the issuer writes a naked credit-default swap on the underlying reference(s) they use.

The buyer of that CDS pays a premium, usually in the form of an annual payment (and sometimes something up front too.)

BINGO!  We have "a thing" that throws off an income stream and thus can, and does, form the basis for a CDO!

The "CDOs" that are at issue here were synthetics.

That is, they did not own actual bonds, they were comprised of credit-default swaps that Goldman wrote against subprime mortgage bonds.

This would have left Goldman exposed (as the writer of the swaps) for the potential losses.  Goldman, in turn, bought a CDS from AIG against the "portfolio" in the CDO, thereby laying off the risk on AIG.

Goldman is thus now "net neutral" (provided AIG can pay!) and happy as a pig in slop, as they made money on the origination fees for the CDO and in addition get to skim a nice little bit off the servicing. 

What could possibly go wrong?

More than a few things.

Let’s start with how this CDO got funded.  Remember, it got originated by Goldman writing a bunch of credit-default swaps.  Who bought them?  Someone had to think subprime was going to detonate, because they paid good money for "protection" that would go up dramatically in value if it did, but for which they were going to pay the CDO investors good money if it did not.

It appears that the buyer of those credit-default swaps was, perhaps, John Paulson:

“Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking.”

Ah, so the allegation contained here is that John Paulson (of hedge fund fame, not to be confused with Hank Paulson the ex-treasury secretary) combed through the pile of subprime mortgage bonds that were out there and handed Goldman a list of "what I want in there", then offered to buy the Credit Default Swaps that would pay out at a huge multiple if and only if those underlying bonds failed to perform.

In other words Paulson combed through the data available on these subprime mortgage deals and picked out the crappiest of the garbage – the most-rotting of the dead fish, all of which allegedly were "AAA" at the time one would presume but which he was quite sure would soon be either downgraded - or default outright - and then asked Goldman to use those as the references against which it would write the swaps that Paulson wanted to buy.

But remember – Goldman didn’t buy the bonds to set up the CDO – they just issued a credit-default swap, which, it appears, Paulson’s hedge fund bought.

Goldman then went out and solicited people to buy the tranches of the CDOs, selling what was alleged to be a cash-flow stream that Mr. Hedgie had offered (out of the goodness of his heart, no doubt – ed: yes, that’s sarcasm) to fund!

Here’s the question:

Did Goldman disclose to the potential buyers in the offering circular that John Paulson had come to them with a laundry list of characteristics he wanted in the CDO and offered to fund the credit-default swaps which would only make him money if those reference bonds blew up, and that he would take large, material losses IF THE SECURITIES – AND THE CDO – PERFORMED AND ACTUALLY GENERATED THE CASH FLOWS PROMISED?

I don’t have a copy of the offering circulars for these CDOs.  Perhaps someone does and can forward them to me. 

But somehow I find it hard to believe that it was made clear to the buyers of these tranches before they plunked down their money that they came into existence because a wise guy came to the bank and asked for them to create a synthetic CDO with specific characteristics and that they would provide the cash flow to be paid to their investors - but that the essence of their desire in setting this up was that they believed the reference instruments would default and in doing so they would become rich while the tranche buyers would be left with little or nothing!

You can say that the buyers of the CDOs should have done their due diligence.  Ok, I’ll grant you that.  You can also say that the ratings agencies had no business granting "AAA" ratings on underlying securities with such shaky repayment prospects, and I’ll agree with that too.

But this leaves open the question of whether it is fair, just, or even legal to create a synthetic security that at it’s core comes into existence because someone believes that the reference is going to detonate, and then sell off pieces of that security to investors without prominently disclosing the source of the funding of the cash flow, that they proffered the criteria for inclusion in the reference and that the INTENT of their funding was to profit from an EXPECTED detonation of the reference securities.

It also leaves open the question of laying off that risk on an insurance company (whether in a regulated subsidiary or not) without similarly disclosing the above to them up front!  That is, is it fair, just (or even legal) to buy fire insurance on a property when you have been told that someone expects a fire in that structure based on what they believe is credible analysis (e.g. a look at the wiring plan), without telling the insurance company about what you were told?

I don’t have answers to the questions about the propriety or legality of these actions.  But I can opine on my view of the ethics involved in such a set of transactions by a bank, and that’s easy: this, in my opinion, is nothing more or less than intentionally screwing people.  That is, this is not about "intermediation" or any such claptrap – it was, in my opinion, a pure act of financial rape-for-profit.

These sorts of "naked" positions – whether in the form of a raw naked Credit Default Swap or in the form of a "synthetic" CDO – must be barred for creation, trading, management and handling in all of their forms by any entity subject to any form of federal or state regulation or backstop, including but not limited to banks, insurance companies, pension funds and similar entities.

If hedge funds wish to bet amongst themselves on the life (or death) prospects for a given reference security, let them do so.  I don’t care one whit if John Paulson is right or wrong – he’s entitled to place his bets and make (or lose) money as fate and skill dictate.

But he should not be entitled to solicit a bank, investment or otherwise, to peddle off securities to others and obtain what amounts to insurance on their performance, while not fully disclosing to everyone involved that THE VERY REASON THIS SECURITY EXISTS is that he wanted to place a bet that the reference on which this security was based would detonate, and that if he is correct in his analysis THOSE WHO BUY AND INSURE THIS "SECURITY" WILL FIND THEMSELVES HOLDING A PILE OF USED TOILET PAPER.

 

Pentagon Breeding Immortal Synthetic Organisms

No really, this is real. Arguably, the randomness of evolution is not good enough, and the Defense Advanced Research Projects Agency (DARPA) has other ideas of how nature ought to work. – Ilene

Pentagon Breeding Immortal Synthetic Organisms

Courtesy of Jason Louv at Dangerous Minds

 

This report on Pentagon genetic engineering is rather, eh, eerie, wouldn’t you say? This is how Captain America was created, you know. And just about every comic book experiment-gone-wrong villain, too. Hell, the whole Weapon X program. Nothing tasteful can come of this!

The Pentagon’s mad science arm may have come up with its most radical project yet. Darpa is looking to re-write the laws of evolution to the military’s advantage, creating “synthetic organisms” that can live forever — or can be killed with the flick of a molecular switch.

As part of its budget for the next year, Darpa is investing $6 million into a project called BioDesign, with the goal of eliminating “the randomness of natural evolutionary advancement.” The plan would assemble the latest bio-tech knowledge to come up with living, breathing creatures that are genetically engineered to “produce the intended biological effect.” Darpa wants the organisms to be fortified with molecules that bolster cell resistance to death, so that the lab-monsters can “ultimately be programmed to live indefinitely.” [i.e., like cancer cells? - Ilene]

Of course, Darpa’s got to prevent the super-species from being swayed to do enemy work — so they’ll encode loyalty right into DNA, by developing genetically programmed locks to create “tamper proof” cells. Plus, the synthetic organism will be traceable, using some kind of DNA manipulation, “similar to a serial number on a handgun.” And if that doesn’t work, don’t worry. In case Darpa’s plan somehow goes horribly awry, they’re also tossing in a last-resort, genetically-coded kill switch.

(Danger Room: Pentagon breeding supersoldier shits)

Continue Wired article here.>>

 Photo: VA.gov

 

Employment Data ABCs

Employment Data ABCs

Courtesy of John Lounsbury at Piedmonthudson’s Weblog

Comments on employment data, especially over the past few days, indicate that many are confused about what the data means, how reliable/unreliable it is, and whether or not it is politically motivated. I have written past articles in which many details of how the DOL (U.S. Dept. of Labor) numbers should and should not be used. One of these (here) was a very detailed examination of various aspects of DOL processes. In this article, I want provide a summary update of the earlier work and add some new details.

Political Manipulation

I will address the third concern first. I can find no evidence that there is any political influence whatsoever in the collection and analysis of the employment data. The processes are well defined and stable over long periods of time. In fact, this very stability can produce errors in analysis models that need to be corrected when the historical form of the models starts to deviate from new economic reality.

The Birth/Death Adjustment

The most notable example of model drift is the birth/death adjustment, which has recently overstated the estimate of jobs created by new business formation before the new companies actually show up in the DOL’s Establishment Survey. These estimates are adjusted for 12 month data intervals almost a year after the fact, when new business formation can be more accurately accounted for from state tax and business records.

The ex post facto corrections made necessary by this “wandering model” were applied this month to data for April 2008 through March 2009. A total of 930,000 non-farm payroll job losses were added to those twelve months. Interim adjustment corrections were also made this month for April through December 2009. This will presumably reduce the corrections needed in February 2011 for the period April 2009 through March 2010.

The Establishment Survey

This is one of two monthly surveys conducted by the DOL. It covers approximately 140,000 businesses and government agencies (~410,000 work locations). The output of this survey consists of employment analysis of various segments of the economy, such as retail, manufacturing, construction, mining, transportation, education and health services, government, etc. The average weekly hours worked is also determined by this survey. It is the data used to produce the non-farms payroll report.

In spite of the fact that the non-farms payroll number is widely reported, it has nothing to do with total employment, unemployment, determination of the civilian labor force and the unemployment rate. The DOL estimate of sampling error for the Establishment Survey is +/-74,000. This is may be too low in the current environment, once the birth/death adjustment is taken into account, because the average correction per month from April 2008 through March 2009 was 72,000. For the months April 2009 through December 2009, the correction applied this month (February) averaged 44,000.

The non-farms payroll employment number each month currently has less meaning than it has had traditionally.

The Household Survey

This survey covers 60,000 randomly selected households each month. People covered in this survey include those on payrolls plus those excluded from the Establishment Survey, including the self employed, 1099 sub-contractors, employees of mom and pop concerns, etc.

This survey produces the data for calculating the number employed, the number unemployed, the civilian labor force, the number not in the labor force, those not working who want work but are too discouraged to look, and the unemployment rate. The only adjustment applied to this data is for seasonality, which will be discussed in a later section.

The measurement error uncertainty for the Household Survey is +/-300,000 in the number employed. For a civilian labor force in the vicinity of 150 million, the ratio to 60,000 sample size is 2,500. Dividing that ratio into the uncertainty above, we get +/-300,000/2,500 = +/-120. That implies that there is a 90% confidence that the 60,000 households accurately reflect the entire population within +/-120 people.

Note: If the 60,000 households actually cover 1.5 employed or unemployed persons each, then the survey actually covers 90,000. The number above becomes +/-180, which is an easier tolerance to reach. These numbers can be compared to +/-167 estimated previously by a different method.

What the DOL Says about Significant Changes

The DOL Bureau of Labor Statistics – BLS – indicates than changes roughly 1.3 times the measurement error are needed for 90% confidence that a change has occurred. In the following quote CPS refers to the Household Survey and CES refers to the Establishment Survey:

The coefficient of variation (CV) is 1.9 percent on national monthly estimates of employment level from the CPS, which translates into a change of 0.2 percentage point in the unemployment rate being significant at the 90-percent confidence level. Because the CPS has a much smaller sample than the CES, its margin of error on the measurement of month-to-month employment change is much larger. For a monthly change in CPS employment to be significant, it must be about plus or minus 400,000, while the threshold of significance for total CES employment is 104,000.

The Number of Unemployed and the Civilian Labor Force

The survey procedures for determining the number of unemployed and the number to be counted in the labor force are very clear. There is much room for debate about whether these procedures are optimal. Specifically, those not working are classified on the following basis:

1. Those not working who have looked for work in the previous four weeks are classified as unemployed and in the civilian labor force.
2. Those not working who have not looked for work in the preceding four weeks are not classified as unemployed and are classified as not in the civilian labor force.
3. Those not in the civilian labor force are classified as “discouraged” workers if they answer affirmatively certain qualifying questions indicating they want work or would accept work, even though they are not actively looking for work.

The unprecedented decline in the civilian labor force over the past nine months (1.8 million) may be a result of people who will come back into the labor force when things improve, but for now are being relegated to the “not in the civilian labor force” category.

For the same reason, the true number of unemployed may be undercounted by a similar amount. This is a consequence of economic conditions and not manipulation by the DOL. They are using the same survey questions they always have.

However, it is a fair question to ask if adding some additional questions might get some data that would bear on the nature of the cadre of discouraged workers not currently counted as unemployed or as members of the labor force.

Significance of Recent Changes in the Unemployment Rate

The changes from month to month in the unemployment rate from the October high of 10.2% have absolutely no significance. I will give two examples, using +/-400,000 from the BLS (above). The 90% confidence interval for the 10.2% unemployment rate in October creates a window of rates from 9.9% to 10.4%. For the January report of 9.7%, the window is from 9.3% to 10.0%. The fact that the change has been continuously level and down for four months is significant, but the change from December at 10.0% (90% confidence window 9.7% to 10.2%) has no significance.

You hear much talk about the important drop in the unemployment rate from December to January. It’s “blitherage”. (Please indulge my invented word.) This is talk about fairies on the head of a pin.

Note: See Appendix 1 for a quote on significance from the DOL, which differs from mine above.

The Seasonality Adjustments

The DOL applies seasonal adjustments, described in Appendix 2. The annual changes in the civilian labor force has been calculated for the past 18 years and plotted in the following graph. The seasonally adjusted (SA) data and not adjusted (NSA) annual changes do not agree exactly. The differences are in both directions with SA sometimes greater than NSA and sometimes less.

Note that two years 2005 and 2006 have the largest differences between seasonally adjusted data and non adjusted data. Curiously, the NSA data shows a larger labor force gain in 2005 and the reverse (SA larger) occurred for 2006. For the two years taken together, the sum of the NSA data and the SA data are nearly equal. I have no rationale to offer for this situation.

The following graph shows the SA and NSA data for employment. The agreement observed between SA data and NSA data is similar to the labor force graph. For employment, 2005 shows a very large difference between adjusted and unadjusted data and 2006 had less difference (than 2005), but is also larger than the other years.

The table below summarizes the agreement/disagreement between SA and NSA data. Data for 16 years falls within +/- 0.1% agreement between the annual changes calculated using NSA data and SA data. However, the data for 2005 and 2006 is much different. I would like to know the DOL explanation for this.

The disagreements falling within +/-0.1% (except for the renegade 2005-2006 interval) corresponds to an error equal to or less than the order the order of +/-120,000 to +/-150,000. Since the annual changes are calculated by the differences between two numbers each with an uncertainty of +/-300,000 the small disagreements between NSA and SA data indicate the seasonality adjustments are consistent from year to year and do not introduce bias.

Three of the four renegade data points fall in the range of +/-300,000 to +/-400,000, so those results are also within the range consistent with the uncertainty in the individual data points. The result for employment in 2005 is way outside what would be expected, of the order of 1% difference (+/-1.5 million). Again, I would like the DOL explanation for this.

Using Moving Averages

I have found it useful to smooth employment data using 4-month moving averages. An example is the following graph from last week’s article at TheStreet.com:

Moving averages smooth the data in a way that makes possible extrapolating forward from noisy data. The use of the 4-month moving average decreases the measurement error uncertainty present in the monthly data. The uncertainty in the moving average can be estimated by recognizing that the uncertainty is proportional to the standard deviation of the data sets. The equation for standard deviation of a data set is inversely proportional to the square root of the number of samples. See Appendix 3.

The 4-week moving average with each week having 60,000 data points is the equivalent of having 4 x 60,000 = 240,000 data points. The ratio is 4/1, with a square root of 2. If the uncertainty in the total population projected from a sample of 60,000 is +/- 300,000, then quadrupling the sample cuts the uncertainty regarding the entire population in half. The 4-week moving average has an uncertainty approximately +/-150,000.

Conclusions

There are a number of things necessary to avoid going crazy dealing with employment numbers.

1. Recognize that a lot of what is published in the media reflects no understanding of what is significant and what is noise.
2. Do not confuse the two different surveys and what is done with data from each.
3. Recognize that moving averages are often needed to make any short term extrapolations.
4. Don’t obsess on political interference with employment data. I can find no evidence that there is any political manipulation of the surveys or data analysis.
5. Accept that adjustment model errors do occur (like the birth/death model) that require later correction. I have found no adjustments with modeling errors in the data that is used to determine employment, unemployment, the rate of unemployment, the civilian labor force and the number not in the labor force.
6. Realize that the criteria for excluding people not working from the ranks of the unemployed and the civilian labor force is something worth reexamining.

I’m sorry to disappoint those that want to find a conspiracy theory. I am always looking for such, but I don’t find it in the Dept. of Labor or the Bureau of Labor Statistics. I would like to see more of the raw data published, but the model adjustments are published monthly so the raw data can be back calculated. And, I do believe that there are more ways to use the data in a productive way than has been done to date. One example is the proposal to use a standard work week and hours worked to define the level of unemployment, as published here.

Appendix 1: DOL Discussion of Confidence Intervals

A discussion of confidence intervals can be found here.

For example, the confidence interval for the monthly change in total nonfarm employment from the establishment survey is on the order of plus or minus 100,0001. Suppose the estimate of nonfarm employment increases by 50,000 from one month to the next. The 90-percent confidence interval on the monthly change would range from -50,000 to +150,000 (50,000 +/- 100,0002). These figures do not mean that the sample results are off by these magnitudes, but rather that there is about a 90-percent chance that the "true" over-the-month change lies within this interval. Since this range includes values of less than zero, we could not say with confidence that nonfarm employment had, in fact, increased that month. If, however, the reported nonfarm employment rise was 250,000, then all of the values within the 90-percent confidence interval would be greater than zero. In this case, it is likely (at least a 90-percent chance) that nonfarm employment had, in fact, risen that month. At an unemployment rate of around 5.5 percent, the 90-percent confidence interval for the monthly change in unemployment as measured by the household survey is about +/- 280,000, and for the monthly change in the unemployment rate it is about +/-0.19 percentage point.

Appendix 2: Seasonality Adjustments

The following is a statement from Chapter 1, BLS Handbook of Methods

Over the course of a year, the size of the Nation’s labor force, the levels of employment and unemployment, and other measures of labor market activity undergo sharp fluctuations due to such seasonal events as changes in weather, reduced or expanded production, harvests, major holidays, and the opening and closing of schools. Because these seasonal events follow a more or less regular pattern each year, their influence on statistical trends can be eliminated by adjusting the statistics from month to month. These adjustments make it easier to observe the cyclical and other nonseasonal movements in the series. In evaluating changes in a seasonally adjusted series, it is important to note that seasonal adjustment is merely an approximation based on past experience. Seasonally adjusted estimates have a broader margin of possible error than do the original data on which they are based, because they not only are subject to sampling and other errors but also are affected by the uncertainties of the seasonal adjustment process itself.

Appendix 3: Standard Deviation

The standard deviation of a data set is defined by the following equation:

Disclosure: No stocks mentioned.

 

Senior Chinese Military Officers Join Iran In Delivering “Punch” To U.S., Propose Selling Treasuries As Arms Sales Punishment

Senior Chinese Military Officers Join Iran In Delivering "Punch" To U.S., Propose Selling Treasuries As Arms Sales Punishment

Courtesy of Tyler Durden at Zero Hedge

And you were worried about Iran. China’s People Liberation Army has come out and openly said that the nuclear option, i.e., selling US Treasuries, is now on the table and should be exercised as "punishment" for U.S.’ arms sales to Taiwan. China undoubtedly realizes that this is a prime example of sado-masochism as the resultant plunge in Treasuries that would follow would hurt the US certainly, but also have a "mild to quite mild" impact on China’s $700 (and likely much greater) UST holdings. Game theory 101 just got interesting.

From Reuters: 

Senior Chinese military officers have proposed that their country boost defense spending, adjust PLA deployments, and possibly sell some U.S. bonds to punish Washington for its latest round of arms sales to Taiwan.

 

The calls for broad retaliation over the planned U.S. weapons sales to the disputed island came from officers at China’s National Defence University and Academy of Military Sciences, interviewed by Outlook Weekly, a Chinese-language magazine published by the official Xinhua news agency.

The interviews with Major Generals Zhu Chenghu and Luo Yuan and Senior Colonel Ke Chunqiao appeared in the issue published on Monday.

The People’s Liberation Army (PLA) plays no role in setting policy for China’s foreign exchange holdings. Officials in charge of that area have given no sign of any moves to sell U.S. Treasury bonds over the weapons sales, a move that could alarm markets and damage the value of China’s own holdings.

While far from representing fixed government policy, the open demands for retaliation by the PLA officers underscored the domestic pressures on Beijing to deliver on its threats to punish the Obama administration over the arms sales.

"Our retaliation should not be restricted to merely military matters, and we should adopt a strategic package of counter-punches covering politics, military affairs, diplomacy and economics to treat both the symptoms and root cause of this disease," said Luo Yuan, a researcher at the Academy of Military Sciences.

Not only that, but China is now openly escalating vis-a-vis Taiwan.

Chinese has blasted the United States over the planned $6.4 billion arms package for Taiwan unveiled in late January, saying it will sanction U.S. firms that sell weapons to the self-ruled island that Beijing considers a breakaway province of China.

China is likely to unveil its official military budget for 2010 next month, when the Communist Party-controlled national parliament meets for its annual session.

The PLA officers suggested that budget should mirror China’s ire toward Washington.

"Clearly propose that due to the threat in the Taiwan Sea, we are increasing military spending," said Luo.

Last year, the government set the official military budget at 480.7 billion yuan ($70.4 billion), a 14.9 percent rise on the one in 2008, continuing a nearly unbroken succession of double-digit increases over more than two decades.

Next question: will China follow through on the increasingly populist sentiment to hurt the U.S. If the U.S. is any indication of the strength of populist anger, now may be a good time to take some "profit", or book the loss as the case may be, in that 30 Year position.

 

Senior Chinese Military Officers Join Iran In Delivering "Punch" To U.S., Propose Selling Treasuries As Arms Sales Punishment

Senior Chinese Military Officers Join Iran In Delivering "Punch" To U.S., Propose Selling Treasuries As Arms Sales Punishment

Courtesy of Tyler Durden at Zero Hedge

And you were worried about Iran. China’s People Liberation Army has come out and openly said that the nuclear option, i.e., selling US Treasuries, is now on the table and should be exercised as "punishment" for U.S.’ arms sales to Taiwan. China undoubtedly realizes that this is a prime example of sado-masochism as the resultant plunge in Treasuries that would follow would hurt the US certainly, but also have a "mild to quite mild" impact on China’s $700 (and likely much greater) UST holdings. Game theory 101 just got interesting.

From Reuters: 

Senior Chinese military officers have proposed that their country boost defense spending, adjust PLA deployments, and possibly sell some U.S. bonds to punish Washington for its latest round of arms sales to Taiwan.

 

The calls for broad retaliation over the planned U.S. weapons sales to the disputed island came from officers at China’s National Defence University and Academy of Military Sciences, interviewed by Outlook Weekly, a Chinese-language magazine published by the official Xinhua news agency.

The interviews with Major Generals Zhu Chenghu and Luo Yuan and Senior Colonel Ke Chunqiao appeared in the issue published on Monday.

The People’s Liberation Army (PLA) plays no role in setting policy for China’s foreign exchange holdings. Officials in charge of that area have given no sign of any moves to sell U.S. Treasury bonds over the weapons sales, a move that could alarm markets and damage the value of China’s own holdings.

While far from representing fixed government policy, the open demands for retaliation by the PLA officers underscored the domestic pressures on Beijing to deliver on its threats to punish the Obama administration over the arms sales.

"Our retaliation should not be restricted to merely military matters, and we should adopt a strategic package of counter-punches covering politics, military affairs, diplomacy and economics to treat both the symptoms and root cause of this disease," said Luo Yuan, a researcher at the Academy of Military Sciences.

Not only that, but China is now openly escalating vis-a-vis Taiwan.

Chinese has blasted the United States over the planned $6.4 billion arms package for Taiwan unveiled in late January, saying it will sanction U.S. firms that sell weapons to the self-ruled island that Beijing considers a breakaway province of China.

China is likely to unveil its official military budget for 2010 next month, when the Communist Party-controlled national parliament meets for its annual session.

The PLA officers suggested that budget should mirror China’s ire toward Washington.

"Clearly propose that due to the threat in the Taiwan Sea, we are increasing military spending," said Luo.

Last year, the government set the official military budget at 480.7 billion yuan ($70.4 billion), a 14.9 percent rise on the one in 2008, continuing a nearly unbroken succession of double-digit increases over more than two decades.

Next question: will China follow through on the increasingly populist sentiment to hurt the U.S. If the U.S. is any indication of the strength of populist anger, now may be a good time to take some "profit", or book the loss as the case may be, in that 30 Year position.

 

Dubya, Hank Paulson’s Surrogate Mother, Urged The Bald To Exercise, Sleep

Dubya, Hank Paulson’s Surrogate Mother, Urged The Bald To Exercise, Sleep

Courtesy of Tyler Durden

Welcome to 1984, where outright propaganda and lies bombard you from current and prior administration officials each and every day. Here is the latest:

And here is our translation:

• Bush has good, fundamental understanding of markets – Interpretation: see here.
• Chinese save too much – Interpretation: Come to America and buy your plasma screens in this country
• Americans borrow too much – Interpretation: Americans LTV is about 10E^TARP
• US will get back every penny put into banks – Interpretation: US will lose every penny put into banks
• Buffet was a "pillar of strength for Paulson." – Interpretation: Buffett’s multi-billion bet on the S&P never declining was a future pillar of destruction for BRK
• He couldn’t say no to his country on Treasury job – Interpretation: he couldn’t say no to the opportunity to cash out of his $700 million Goldman stock stash
• A faltering Chinese economy would be bad for U.S. – Interpretation: see here.
• Without TARP US would have had 25% unemployment – Interpretation: With TARP Lloyd Blankfein will be a trillionaire, as companies cut SG&A to 0, unemployment hits 100% and Net Income becomes Revenue.
• Chinese need to reform currency – Interpretation: We need to kill the dollar, those bastards over there are making it impossible.

 

 

 

Small Businesses Owners’ Association Slams Obama’s Stimulus Efforts, Sites Weak Demand and Poor Sales

Small Businesses Owners’ Association Slams Obama’s Stimulus Efforts, Sites Weak Demand and Poor Sales

Courtesy of Mish

Small business optimism inched higher but all it really means is things are getting worse at a falling rate. Please consider U.S. Small-Business Optimism Index Rose in January.

Confidence among U.S. small businesses increased in January for the first time in three months as the outlook for sales improved, according to the National Federation of Independent Business optimism index.

The gauge climbed to 89.3, the highest level in 16 months, from 88 in December, the Washington-based organization said today. The advance left the measure close to the 2009 low of 81 reached in March, which was second only to a 1980 reading as the lowest on record.

Three of every 10 companies surveyed said a lack of sales remained their biggest concern even as the demand outlook turned positive for the first time since January 2008, the month after the recession began. A majority of small businesses expect profit and employment to decline, showing why the Obama administration has announced new plans aimed at providing credit and tax breaks to small firms.

“This is very disappointing for an indicator of the health of the most critical segment of the economy in terms of new job creation,” said Joshua Shapiro, chief U.S. economist at MFR Inc. in New York.

“The good news was less bad news,” William Dunkelberg, chief economist at the NFIB, said in a statement. “Optimism has clearly stalled in spite of the improvements in the economy in the second half of 2009.”

President Obama last week announced he will back a temporary increase in Small Business Administration loans to $1 million from $350,000 to encourage hiring. He has previously endorsed $33 billion in small business tax cuts and incentives for hiring as well as a plan to use $30 billion of bailout money paid back by Wall Street financial institutions to help community banks make loans to small businesses.

Such aid is “misdirected,” NFIB’s Dunkelberg said in the statement, because the top problem for small business leaders is weak demand rather than a lack of credit. Stimulus therefore should focus on reviving consumer spending, he said.

Recovery In Doubt

Please consider No Job Growth for Small Business Spurs Recovery Doubt.

Small businesses are becoming the Achilles heel of the U.S. recovery by limiting growth and job creation.

The National Federation of Independent Business’s index of small-business optimism has been near historic lows for 15 consecutive months, declining to 88 in December from 88.3 in November, the federation reported Jan. 12. During the four prior recessions, it dipped below 90 only once.

Recent numbers suggest “the official data are too heavily weighted towards bigger companies, which are doing better than credit-constrained smaller firms,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York. “The latter employ half the workforce.”

The nation’s monthly payroll figures are inflated because the Labor Department model that estimates small-business hiring has overstated the number of jobs added during the recession, Shepherdson says.

According to the model, small companies created an average of 113,000 jobs a month from February through December — a period when total employment fell by a nonseasonally adjusted 3.7 million, Labor Department statistics show.

The model “is creating jobs out of thin air that are not actually being generated,” Joshua Shapiro, chief U.S. economist at MFR Inc., an economic-consulting firm in New York, said in a Feb. 4 note to clients.

NFIB Slams Washington

Inquiring minds are reading NFIB Small Business Trends February 2010.

Washington still does not get it. It pays lip service to the fact that small business generates half of private sector GDP and creates over two-thirds of private sector net new jobs, but when it comes time to provide help, small business gets $30 billion IF banks decide to accept the TARP funds to support loans and IF the owners can subsequently get a loan from a bank. But for most firms, this dinky amount is of little help. More so, this new aid misses the main problem since only five percent of small business owners cite “financing” as their top business problem but 31 percent cite “poor sales.”

We are building less than half of the number of housing units normally constructed, putting a huge dent in mortgage and construction loan demand. We are also buying two-thirds the number of cars normally purchased, so auto credit demand is way off too. Plans for capital expenditures and inventory investment among small firms are at 35 year lows. Even large bank CEOs now admit loan demand is weak! “Stimulus”
for this administration has not focused on supporting consumer spending nor been designed with a sense of urgency as central to policy formulation.

Instead, Congress is focusing on a health care bill that features crippling taxes and mandates for small firms, fully expecting to have it in place and implemented (10 years of taxes, seven years of “reform”) this year with unemployment at 10 percent and expected by many to rise. Lawmakers also allowed the minimum wage to rise by nearly 11 percent in July 2009, catapulting teen job loss to over 500,000 and an unemployment rate of 27 percent in the second half even though the economy started growing. This was double the loss in the first half when GDP growth was plummeting.

If the administration wants to count “jobs created and saved” it should also be accountable for “jobs destroyed or prevented.”

Obama’s Misguided Plan
 

The Administration wants banks to lend money to small businesses. It also wants small businesses to hire. However, in spite of all the rhetoric coming out of DC, the problem is not lack of credit, something I have noted many times.

There simply is no reason for businesses to hire with demand so weak.

Giving tax credits to businesses who hire is a total waste of taxpayer money. It will benefit large corporations who were going to hire anyway. It will do nothing for small businesses who have no plans to hire.

On the other hand, raising the minimum wage and increasing taxes will both hurt small businesses. So do Obama’s tax hikes and so do state tax hikes. The latter primarily feeds money to an already bloated public sector at the expense of everyone else.

Mike "Mish" Shedlock

 

 

Seniors Need Yield But Nowhere Good To Go; FDIC Moral Hazard Yet Again

Seniors Need Yield But Nowhere Good To Go; FDIC Moral Hazard Yet Again

Courtesy of Mish

One of the many massive distortions caused by the Fed’s miserable policies is hitting hard on senior citizens who cannot afford stock market losses but need fixed income to live on.

"California Banker" writes

Hey Mish

During the past several weeks we’ve had a lot of seniors coming to the bank as their certificate of deposits of mature. They are very disgruntled about the rate environment in general as bank rates are much lower than a year ago.

Many of these seniors are 70 and up and are using the interest to live on in retirement, so their interest income has taken a hit. I imagine most of those living off their interest will likely need to burn net worth to maintain living expense.

Some are moving their deposits to banking institution that a paying a slightly higher rate, which is typically an institution that is struggling and needs the deposit.

"California Banker"

To make a few extra pennies, senior citizens pull money out of rock solid institutions in favor of pathetically undercapitalized, troubled banks. But hey, it’s FDIC insured. Why not?

Hello Sheila Bair, can’t you see what’s happening?

Mike "Mish" Shedlock

 

The Latest From Germany: “Greece Must Solve Own Budget Problem”

The Latest From Germany: "Greece Must Solve Own Budget Problem"

Courtesy of Tyler Durden

Crazy pill time. More disinformation as we get it. Is Germany merely probing to see the market reaction to leaks? If the Bund collapses can they just call the whole thing off?

From Market News:

The spokesman for Germany’s coalition government has denied that Berlin is close to unveiling a plan for financial aid to fiscally-troubled Greece.

The spokesman, Ulrich Wilhelm, rejected earlier reports that a Greece package was nearly a done deal, calling them "incorrect."

Earlier this evening the Financial Times Deutschland as well as some financial wire services reported that the German government is preparing a rescue package for Greece, citing sources close to the ruling coalition.

The FTD report said the rescue package could include bilateral aid as well as internationally agreed action at the European Union level. It also said that Finance Minister Wolfgang Schaeuble would inform the leadership of his party about details of the plan on Wednesday.

The paper cited its sources as saying that a European solution is sought but aid from Germany alone is not excluded.The deputy parliamentary leader of the Christian Democratic Union/Christian Social Union group, Michael Meister, confirmed to the FTD that a rescue package is being worked on in Berlin, but insisted there would be strings attached.

"If Greece obtains help, then only under strict conditions and only if the Greek government drastically reforms the state," he remarked.

Wilhelm, the government spokesman, didn’t say one way or the other whether a plan was being worked on – just that no decision on it was close at hand.

However, Handelsblatt reported Wilhelm as saying that a solution to the Greek problem "now depends on the government in Athens itself solving its budget problems sustainably."    
        
 

What a day for Greek CDS traders.

 

Dow Now Up 200 On Greek Bailout

Dow Now Up 200 On Greek Bailout

Courtesy of Joe Weisenthal at Clusterstock

This feels like that day back in October 2008 when CNBC broke the news of something witht he acronym "TARP" and markets went crazy. Of course, the euphoria proved to be short-lived.

This time the bailout is in Europe. Hopefully things work out better this time.

The Dow is up 200 and is now up on the month.

See Also:

Market Explodes Higher As EU Prepares Greece Bailout

 

Hmmm… Do We Need To Guillotine The WTO?

Hmmm… Do We Need To Guillotine The WTO?

Courtesy of Karl Denninger at The Market Ticker

That sounds dramatic – even drastic.

But is it?

There’s an argument raised over at "Washington’s Blog" that the real cause of all the financial problems -the global mess – is the WTO:

On March 1, 1999, countries accounting for more than 90 per cent of the global financial services market signed onto the World Trade Organization’s Financial Services Agreement (FSA). By signing the FSA, they committed to deregulate their financial markets.

But let’s be straight here.

"Deregulate" does not give license to fraud, even though there are some who would argue otherwise. 

The root issue with all of these "financial products" is that they are unmarketable unless someone lies.

You can’t sell a "structured product" comprised of liar loans if you’re honest about the "qualifications" (or rather, the lack thereof) of the borrowers at anything approaching a profitable rate of return.  Nobody will buy.

With honest ratings a CDS + Bond will always yield less than the risk-free rate of return.  This is because nobody works for free, and the more complex something is, the more it costs.

These are facts, not suppositions.

So WTO or no WTO, without willful blindness toward fraudulent practices the market will take care of the scoundrels.  Without the ability to lie – that is, if we simply lock up all those who misrepresent credit quality the liar loan + CDS will yield less than a Treasury of equivalent duration, and as a consequence the purveyor of those liar loans will have to price them at a rate that accurately reflects their risk of default (plus his profit).

This instantly cuts the BS.

Yes, we could simply tell the WTO to get stuffed, and I can make a cogent argument that we should – for a number of reasons, not the least of which is that "free trade" doesn’t make allowance for those working under literal (or near-literal) slave conditions, such as Chinese and Vietnamese workers who are working under effective conditions of indentured servitude and lack the human and labor rights protections we enjoy in civilized nations.  "Competing" with a labor source that effectively has a gun in its mouth is not only impossible, the concept is idiotic on its face.

But that’s irrelevant to the argument that "we were forced by treaty to deregulate." Among other things deregulation does not mean legalizing fraud and never has. 

Second, the WTO’s "FSA" appears to have never been sent to Congress and thus has no force of law as a treaty.  It is a mere "suggestion" – and one that Congress has every right to ignore, as do our regulators, as under The Constitution all Treaties must be ratified by The Senate – without that consent any purported "international agreement" is of no legal force whatsoever.  Treaties cannot be amended once voted upon without being subjected to a second vote (and possible refusal); the FSA was an amendment to an existing treaty, and thus without being considered by The Senate is a nullity in terms of actual United States obligations.

The "globalists" (and scaremongers who believe we have sold out to them) would have you believe that we have somehow obligated ourselves.  This is false.  We have done no such thing, and whether our government has complied with these wishes (some would say demands) out of a desire to appease those who have bribed legislators with million in campaign contributions the fact remains that when it comes to legal force of law in this regard there is none.

This, by the way, includes the WTO, which has a nice list including the US on the web page referenced above.  That too is, as far as I can determine, a lie as the FSA was never put to Senate Ratification, and without that having occurred it is legally void, whether the WTO likes it or not.

(PS: For those who wish to argue that the Republicans are to blame for all of the world’s ills, you should look into who was President when the negotiations took place on the predicate parts of the treaty that was ratified prior to the FSA "add-on" that has no force of law.  Hint: He tried to hide what he had spilled on a particular blue dress.)

 

Risk, Feedback and the Market’s Next Move

Risk, Feedback and the Market’s Next Move

Courtesy of Charles Hugh Smith Of Two Minds 

Risk has returned to global markets as participants grasp that the central banks’ quantitative easing and massive stimulus have failed to reset the clock to 2006.

Right now there is a forecast for every possible market move. The dollar is about to turn down and gold is about to race higher; or, gold is about to fall to $700/ounce. The global markets are about to embark on a crushing Wave 3 decline to new lows, or the lows of 2009 will not be revisited in our lifetime.

And so on. Nobody knows what’s going to happen. If it were easy to predict the market’s gyrations, we’d all be millionaires.

But rather than rely on dart throws, we can construct a context based on "first principles," which in the Survival+ analysis consist of an integrated understanding of context, causal connections and feedback loops.

Thus we can start by stating that the governments’ collective efforts to reset the global economy to bubbly 2006 with quantitative easing and massive stimulus have failed, and the global markets are pausing now in recognition of this forward uncertainty.

Yes, profits have skyrocketed from the depths of 2008 as corporations have slashed headcount and spending, but you can’t squeeze endlessly rising profits by harvesting the low-hanging fruit of cost-cutting; that’s essentially a one-off that’s already been done globally. To grow profits from here, corporations need sales growth. Any growth dependent on government stimulus is suspect because at some point that stimulus will decline or cease. Hence the uncertainty and sudden appreciation of forward risks to the "endlessly rising profits from endlessly rising sales" story.

In response to the visible failure of their QE/loose money/unprecedented stimulus giveaways, the central banks and their governments have announced more of the same. That is the primary feedback loop: lacking any political courage to tackle the endemic rot at the core of the global economy–excesive borrowing, leverage, bubble-blowing, etc.–then the governments keep pulling the one lever available to them which does not cause any immediate political or financial pain: more QE and more stimulus.

The pain from relying on QE and stimulus–in effect, extricating ourselves from overindebtedness by piling on more public debt–will come later, and hence is politically acceptable.

For context, let’s consider a few charts. As always, please refresh your awareness that there is investment advice on the freely offered site, only the meanderings of an amateur observer (me) by reading the HUGE GIANT BIG FAT DISCLAIMER below.

Any metric derived from price is called a derivative. Thus in calculating the rate of change (ROC) of price we have a first derivative, and if we further calculate the percentage of the ROC then we have a second derivative of price.

This is known as quantititive analysis, a little-understood arm of technical analysis.

Frequent contributor Harun I. submitted several long term charts, one of total NYSE volumes and another of the percentage rate of change (PROC) of the Dow Jones Industrial Average (DJIA). These metrics provide a "beneath the surface" view of the market on a long-term scale which in effect smoothes out not just daily gyrations but weekly and monthly movements as well.

The PROC is a second derivative of the price. By plotting two second derivatives in slightly different time settings, we get a chart similar to MACD or stochastics, in which the two plotted lines crossing provide a signal.

Here are Harun’s comments on the charts.

Below you will find a study of the historical PROC (percent) of the DJIA (yearly). The light blue line is a 4 period SMA of a 4 period ROC. The light green line is a 10 period SMA of a 10 period ROC. The big picture here is that, while the 4 period ROC bottoms first the next cycle will not begin until the 10 period ROC bottoms, which looks like at least another decade off. (emphasis added, CHS)

This assumes that the 100+ year bull market will continue. Note that both ROC’s have spent very little time in negative territory. However, this pattern will not continue indefinitely. At some point there will be a crossover and a sustained period below the zero line. It is likely that these times will be extremely difficult.

If history is any guide, I think this is a realistic view of what may lie ahead. Remember that it is a moving average of the ROC’s so there is a lag. But as you can see the the 10-year SMA of the the 10-year ROC has been fairly accurate.

The thing we should be concerned with most is an upswing at the end of this down-cycle that produces a new nominal high but a lower momentum peak creating a divergence. At this level of trend, such a divergence would be a very grave warning. If the game is not over yet, such an occurrence would probably mark a final blowoff and then things get really interesting for the next century or more.

Some might find this hyperbolic. The very fact that very few think it can happen creates the vulnerability. The millennial cycle is not going to abate just because we say it isn’t so.

Please excuse the low resolution of this chart. I reformatted it to fit the screen.

 

Interestingly, the notion that the market is a full decade away from a true bottom aligns with two other contexts: the Bear market of the 1970s lasted from 1966 to 1982, approximately 16 years in which "buy and hold" investors lost 2/3 of the value of their stock holdings even as nominal prices hovered around DJIA 1,000. (Inflation destroyed 2/3 of the purchasing power of their investments.)

This projection to a market bottom in 2020-2022 also align with the generational forecast made by the authors of The Fourth Turning, which posits a 4-generation (80-year) cycle of major crises (and resolutions) in U.S. history: 1781 (birth of the nation), 1861 (Civil War), 1941 (Depression and world war) and hence 2021 (collapse of the Savior State and Plutocracy status quo, Peak Oil, etc.)

The Wall Street Truism has it that "volume is the weapon of the Bull." If so, this chart reveals that the Bull has been in retreat since 2006, and that the recent global rally is entirely lacking in volume and thus conviction.

Since many observers are obsessing over the direction of gold and its see-saw playmate, the U.S. dollar, I include two shorter-term charts. The UUP is a proxy for the USD and GLD is a proxy for gold. I have constructed the most basic technical system: price and the 50-day moving average.

When price moves above the 50-day MA, that is a bullish trend; when it moves below, that is a bearish trend.

The chart of UUP certainly suggests the downtrend in the dollar has reversed. The chart of GLD is more ambiguous–it could be "resting"/basing for its next leg up, or it could be topping out and about to roll over into a downtrend. Regardless, it is unambiguously bearish to be below the 50-day MA. What is also noteworthy is the extreme volatility in the price of gold. Guessing its next move is not for the faint of heart.

No one knows what the market’s next move will be–there are guesses for up, down and sideways. But a glance at these charts should make us skeptical of forecasts of a new long-term Bull market in equities.

 

THE PROBLEM OF EXPONENTIAL DEBT

THE PROBLEM OF EXPONENTIAL DEBT

Courtesy of The Pragmatic Capitalist

A Chinese proverb known by Americans as the “Chinese curse” says: “may you live in interesting times”.  Boy do we live in interesting times.  This is a veritable golden age in economic evolution.  New theories are being crafted as we speak and old theories that have stood the test of (our short) economic time are being torn down.   No theory has come under fire in recent years like Keynesianism.  After decades of success, Keynesianism doesn’t appear to be having the same magical effect.  Economic theorists are confused.  To their dismay (and with all apologies to Sir John Templeton, to whom I promised I would never utter these words) – it’s different this time.  Literally.

We are fighting a very rare and wretched economic beast.  As Bernanke’s great reflation experiment has ripped higher I have maintained that the hyperinflationists are wrong.  Though we appear to have slipped through the hands of the balance sheet depression Grim Reaper, the balance sheet recession continues to nip at our heels.   At his side always is his good friend Deflation.

A balance sheet recession is so rare that it has only occurred a handful of times in modern economic times.  And thus far, he remains undefeated by all of the powerful economic minds who have stood in his path.  In his path today is the great Sir John Maynard Keynes.   The global economy has stood behind the theories of Lord Keynes as the economy has tumbled and Central Bankers have literally bet their printing presses on his theories.  I fear they are not working and could be setting the table for an even greater catastrophe.

Over the course of the last 75 years governments around the globe have implemented policies of print and spend in times of economic downturns with great success.  The truth is – Keynesianism works – in the right environment.  It works well when debt is fairly low and organic economic growth is relatively strong, but exponential debt growth becomes an increasing concern every time you print your way out of an economic downturn.  The larger the downturn, the larger the response.  So on and so forth.  If you happen to enter a period of severe irrationality and spending the problems multiply.  If the recovery period is not used to pay down debts the problems become exponentially worse.  The tipping point comes when the debt burden hinders future economic growth and destroys your ability to spend your way out of any future recessions.  It effectively turns into one great pyramid scheme if it you let it get out of hand.

Marc Faber believes we are already there.  He refers to the current period in U.S. history as “zero hour” – the point where we have indebted ourselves so deeply that we can’t be trusted to pay off our debts.  Perhaps worse, however, is the inability to fend off future economic downturns.  Not everyone agrees with this perspective, however.

Paul Krugman argues that the deficit worrying is entirely political.   He’s correct to a certain extent, but as someone who loathes politics and understands that money has no political party I can say, without bias, that Krugman is also wrong to a large extent. Krugman argues that the economic downturn caused much of the current budget deficit – as if that somehow justifies it.  But therein lies the problem.  The prior Keynesian responses became multiplied and directly contributed to the current downturn.  20 years of easy money and accommodative print and spend monetary and fiscal policies have finally boiled over.   In essence, we have tried to print and spend our way out of one too many recessions while failing to use the recovery periods to pay down our debts.

The problem is, as the United States economy has matured we have become increasingly confident of future growth and increasingly less fiscally prudent.  The following chart shows the decade change in debt, GDP and debt/GDP.  What was once a sustainable ratio in the 50’s, 60’s and 70’s has ballooned in the 80’s, 90’s and 00’s.   The story in the private sector is largely the same as debt ratios have ballooned in the 90’s and 00’s.

Now, as the recovery remains weak and worries of a double dip increase, Krugman and the other Keynesians are saying we’re not spending enough:

“The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs.”

Talk about doubling down on a losing bet….The truth of the matter is the U.S. economy is on an unsustainable path and our Keynesian economic responses have been large contributors.  As the U.S. economy has matured and growth has slowed our spending has actually picked up pace.  As we became more wealthy as a society we began to price-in increasing wealth expansion and with it came more debt – and more risk.  That’s all well and good until the revenues begin to fall off a bit and then the debts become a substantial constraint.

Reinhart and Rogoff recently published a paper titled “growth in a time of debt”.  They found that debt at 90% of GDP begins to substantially impact future economic growth:

“The relationship between government debt and real gross domestic product (GDP) growth has been weak for debt/GDP ratios below a threshold of 90% of GDP. Above 90%, median growth rates fell by one percentage point and average growth fell considerably more. The threshold for public debt was similar in advanced and emerging economies.”

With the budget expected to reach 95% of GDP this year we are nearing the point of no return.  Not only will the public debt severely hinder our ability to grow our way out of the debt crisis, but this continued growth in debt will severely hinder our response to future downturns.  Remember, I am not an anti-Keynesian.  I simply don’t believe it is applicable in times of a balance sheet recession.

Krugman argues that there is no need to panic about the debts now:

“But there’s no reason to panic about budget prospects for the next few years, or even for the next decade.”

The Rogoff and Reinhart study shows that Krugman is wrong.  The time to worry about the deficit is right now.  Unfortunately, the Keynesian policies which Krugman has promoted, not only contributed to the current downturn, but severely cripple the U.S. economy going forward.  Doubling down or continuing such policies has the potential to create subsequent economic downturns – downturns which we won’t have the option to print a trillion dollars in response to.

My greatest issue with U.S. monetary & fiscal policy over the last decade is a continuing lack of risk management (something, ironically, which is all too prevalent in the money management business as well).   We continue to run up massive debts based on false economic growth assumptions.  Like the consumer who assumed the 90’s would continue forever, (or the banker who created mortgage backed securities assuming real estate could never decline) we continue to spend assuming future growth will be high and recessions will be rare occurrences.  What our policymakers should be asking themselves is how we can best prepare for the worst should the economy grow at a lower than average rate and downturns become more common occurrences.  Instead, they continue asking themselves how quickly we can return to the go-go 90’s.

There is little doubt that Keynesianism works in a time of low debt and stable GDP growth, but this balance sheet recession is different.  And it requires a different solution.  A solution that politicians with short terms in office do not have the stomach (or time) to deal with.

In sum, the idea that you can turn on the debt spigot every time your economy gets into trouble is deeply flawed.  The major flaw in the Keynesian approach is that it ignores  exponential growth in debts.  As a government continually spends and prints to get themselves out of one recession the debt they incur slowly hinders their ability to overcome any impending economic woes.   Should they continue to attempt to print and spend their way out of each subsequent recession it becomes a negative feedback loop.  The debt hinders future economic growth, the potential for subsequent downturns actually increases and the ability to handle those downturns is severely reduced.  If fiscal imprudence continues in times of recovery you end up right where we are today.

Richard Koo, who has helped the Japanese deal with their own devastating balance sheet recession, believes we can spend our way out of this debt crisis.  I disagree.  At this point, our only option appears to be regulatory overhaul and belt tightening – and for a bloated U.S. economy that could mean substantial short-term economic pain.  On the bright side, a little short-term pain will help us in removing the excesses that hinder the economy and will help to lay the foundation for the next great bull market.  Unfortunately, the great Keynesian minds of our day continue to push these failed policies and the politicians in charge are unlikely to bite the bullet given their short-term needs for re-election and instant gratification.  That likely means we confront increasing chances of facing our own “zero hour” and the more we spend the worse we can expect that event to be.

We live in most interesting times, and unfortunately, they are “cursed” not by the times we live in, but by the people who are crafting the economic policies of the times.  This is not the time for more spending.  Disastrously , I fear that our flawed response of bailing out the banks has already hindered our ability to recover.   It would take a great leader and great economic mind to deviate from the flawed paths we have chosen.  Unfortunately, in these “cursed” times neither appears to be in existence.

[Picture from coolmath.com]

 

BLS Seasonal Adjustments Gone Haywire; 11% Unemployment Coming by May?

BLS Seasonal Adjustments Gone Haywire; 11% Unemployment Coming by May?

Courtesy of Mish

Over the weekend I received an email from Irishscot2, a poster on MarketWatch, regarding seasonal adjustments to the unemployment rate.

Hi Mish

I believe the seasonal adjustment is no longer valid given that anticipated job creation down the road has not and will not be happening. I expect late spring to reverse the January effect heading into the elections. If so, a perfect political storm brewing because of their models!

Irishscot2

Irishscot2 compared the unadjusted numbers to the seasonally adjusted numbers on a percentage basis. I could not tell much from the raw data he sent, so I asked for his spreadsheet and he graciously obliged.

It is difficult to visualize raw numbers, especially trends in percentage differences, so I added a column and a couple of graphs to the spreadsheet. Here are the results.

Seasonally Unadjusted Unemployment vs. Unadjusted Unemployment

click on chart for sharper image

The above chart shows how the BLS smoothes the unemployment rate to account for seasonal trends. It also give as hint as to an increasing magnitude of that smoothing.

To highlight the month to month variances, I added a column to show the amplitude of the seasonal adjustments. The result is this chart.

Unadjusted Unemployment Minus Seasonally Adjusted Unemployment

click on chart for sharper image

Seasonal Adjustment Highlights

• There is always a big BLS adjustment in January
• There is always a reversion to the mean that overshoots to the downside between March and April
• There is always a secondary rebound back above the 0.0% line in July, followed by a smaller overshoot to the downside in October.

The problem is in the increasing amplitude of these swings, in both directions. It really makes you wonder just what the hell the BLS is doing and why.

I have data charted all the way back to 1999. Prior to January 2009, the biggest January swing was .6 percent, in both 2004 and 2003. In 2008 the January swing was only .5 percent.

The amplitude of January swings in both 2009 and 2010 was .9 percent, way outside the data range for the last 10 years, by a factor of 50 percent (.3/.6).

Likewise, the prior swings in October peaked at -.4 percent on a couple of occasions but hit -.7% in October 2009.

Unless it’s different this time (I figure it is not) a reversion to the mean that slightly overshoots in a May-June timeframe will lop off a whopping 1.3 percent off the posted seasonally adjusted rate of 9.7 percent just announced.

In other words, all things being equal (no job gains or losses), we could expect to see the unemployment rate approach 11% by May! Of course we have to factor in actual job growth (or lack thereof). We also have to factor in census bureau hiring.

Heaven knows what census hiring will do to the BLS algorithms. Your guess is as good as mine. However, whatever it does, census hiring will also revert to the mean.

Also remember that it takes 100,000 to 120,000 jobs per month just to hold unemployment rate steady. Think that’s going to happen? If so (and again discounting census hiring), then you are living in Bizarro world along with everyone else who thinks the unemployment rate is going to come crashing down.

Real World Analysis

As unbelievable as this may sound, some people do live in the real world, reporting on real data, about real jobs.

Please consider TrimTabs: Here’s Why The Real Jobs Loss Number Was 5x Worse Than What The BLS Reported

TrimTabs employment analysis, which uses real-time daily income tax deposits from all U.S. taxpayers to compute employment growth, estimated that the U.S. economy shed 104,000 jobs in January. Meanwhile, the Bureau of Labor Statistics (BLS) reported the U.S. economy lost 20,000 jobs. We believe the BLS has underestimated January’s results due to problems inherent in their survey techniques.

While the BLS originally reported job losses of 4.2 million in 2009, TrimTabs reported 5.3 million, a difference of more than a million lost jobs.

Since July 2009, TrimTabs estimates and the BLS estimates have diverged again. While the tax data points to a weak job market, the BLS estimates point to a steadily improving job market. We believe the job market is much worse than the BLS is reporting and that in January 2011, when the BLS revises their estimates for 2010, their April 2009 through December 2009 results will move much closer to TrimTabs’ results.

The BLS has seriously underreported job losses for the past two years due to their flawed methodology. TrimTabs has identified the following four problems:

1.The BLS employment estimate is based on a survey, and not on an actual count of employees. While the BLS survey is large and supposedly designed to capture the complex nature of the employment market, it is still a survey and therefore subject to error. TrimTabs believes that rapid changes in an employment cycle cannot be captured by surveys.

….

Real-Time tax withholding data shows that wages and salaries declined an adjusted 1.0% y-o-y. In January 2009, wages and salaries declined 5.0%. If the labor market were improving, we would expect a positive year-over-year growth rate. The fact that tax withholding data is still declining year-over-year suggests that the labor market is still contracting.

The BLS added a whopping 1.92 million jobs to their survey results in January. That is the spike shown in the second chart above. The number is so preposterous one might wonder if it was purposely preposterous. Census hiring may add to the preposterousness of it all, depending on what the BLS does with its models.

However, unless the administration can pull a kangaroo out of a hat, those BLS seasonal distortions will fall on the hard rocks of reality, real jobs, by real people, as opposed to figments of imagination from some very imaginative people at the BLS.

Mike "Mish" Shedlock

Famous Last Words: U.S. Will ‘Never’ Lose Aaa Debt Rating

Famous Last Words: U.S. Will ‘Never’ Lose Aaa Debt Rating

Courtesy of Mish

Treasury secretary Tim Geithner, who arguably belongs in prison for his role in the AIG bailout coverup, is back in the news again.

Please consider Geithner Says U.S. Will ‘Never’ Lose Aaa Debt Rating.

Treasury Secretary Timothy F. Geithner said the U.S. is in no danger of losing its Aaa debt rating even though the Obama administration has predicted a $1.6 trillion budget deficit in 2010.

“Absolutely not,” Geithner said, when asked in an ABC News interview broadcast yesterday whether a downgrade is a concern. “That will never happen to this country.”

Geithner said investors around the world turn to U.S. Treasury securities and dollar-denominated assets whenever they are worried about global stability. That reflects “basic confidence” in the U.S. and its ability to bounce back from the global recession, he said.

Moody’s Investors Service Inc. last week said the U.S. government’s bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.

The U.S. plans to rein in the deficit once the labor market recovers, Geithner said.

Famous Last Words

Notice Geithner’s condition to rein in the deficit "once the labor market recovers". The problem is meeting that clause. A labor market recovery might be a decade away or more depending on the meaning of "recovery".

In response to Geithner’s pomp …

My friend "HB" says "File under famous last words".

My friend "BC" says "Geithner serves stateless elites who can say this with full confidence that their wealth and privilege will remain intact no matter what happens to the real US or global economy and sovereign debt situation in the US and the world. The key for those of us not secure within the rentier Power Elite caste is to continue to make arrangements for escape plans to try to mitigate the worse effects of sovereign defaults, currency devaluations, capital controls, confiscation, etc."

Meaning Of Never

I want to focus on the meaning of "never". Is this the start of one of those what’s the meaning of ‘is’ kind of discussions we had with Clinton? I hope not.

Please note Moody’s rare display of courage to downgrade Enron from investment grade to junk on November 8, 2001.

On December 2, 2001 Eneron filed bankruptcy.

Notice how Moody’s displayed remarkable courage and foresight with a timely downgrade of Eneron from investment status to junk a full 3 weeks before Enron was delisted. Indeed the chart shows how much on the ball Moody’s was (and still is).

Game Is Rigged

Bear in mind that the big three rating agencies (Moody’s, Fitch, and the S&P) have government sponsorship, thus the game is rigged. Please see Time To Break Up The Credit Rating Cartel for details.

As long as the game is rigged (and it is very rigged), US debt will continue to be AAA rated until even pathetic Moody’s cannot take it anymore, or governments sponsorship of the big three ends.

Mike "Mish" Shedlock

 

We’re Weimar

We’re Weimar

Courtesy of James Howard Kunstler

     Future historians who try to chart the unraveling of the USA’s political tapestry might point to two events of the past week.  The obvious first one was the Tea Party convention at Nashville. It was held not accidentally at the ridiculous Opryland Hotel and resort in the city’s outer suburban asteroid belt, right next to the circumferential freeway, and next door to the defunct (1997) Opryland USA theme park, an attraction based on the cute idea that Tennessee rubes were too dumb to spell the word opera — so the symbolism was perfect.

     Behind the incoherent cargo of conflicting complaints that makes up Tea Party doctrine — like "keeping the government’s hands off our medicare!" — stands the more basic dissolution of the Sunbelt’s miracle economy, along with the pain and bewilderment of the southern peckerwood political nexus that rose out of the dust after World War Two to build the suburban nirvana of universal air-conditioning, happy motoring, Jesus tub-thumping, over-eating, and Friday night football that defined Sunbelt culture. They sense now that history is about to thrust them back into the okra patch, with the hookworms and the chiggers, as the economy whirls down the drain, and the car dealerships close up, and the idle production homebuilders succumb to methedrine addiction, and the price of Reba McEntire tickets exceeds their dwindling resources, and they are none too happy about any of that.

     Of course this Sunbelt political culture has tentacles and outposts all over the USA, wherever a few generations of laboring folk enjoyed debt-fueled parabolic rises in living standards during the cheap oil decades, and now find themselves in foreclosure hell, indentured to the very WalMarts that they welcomed with open arms (and allowed to destroy their local businesses) — and, of course, it’s yet another paradox that these are the same folk who will still defend the big box masters to their deaths. The America they stand for is a weird contradictory mish-mash of Confederate nostalgia, hyper-individualism that really owes allegiance to nothing, racial enmity, religious paranoia, and potemkin patriotism — especially involving anything in the constitution that allows them to wriggle out of obligations to the public interest at the same time that they get to push other groups of people around.

     The Tea Party people are the corn-pone Nazis I have been warning you about. They are gathering strength in numbers as President Obama and congress fritter away their remaining legitimacy in a manner of governance that more and more resembles an endless Chinese Fire Drill. The delusional craziness of the Tea Partyists exists in direct proportion to the wimpy deceit of the government, especially in matters of money and statistics reporting. Our political leaders are resorting to wholesale deceit because the truth of our situation — comprehensive bankruptcy — is too painful to dwell on and for the most part they are too chicken too state it.

     This brings me to the second telling event of last week when President Obama said, kind of off-hand, apropos of the US economic situation, "You don’t blow a bunch of cash on Vegas when you’re trying to save for college. You prioritize. You make tough choices."  Senate Majority Leader Harry Reid (of Nevada) was all over Mr. Obama like a cheap suit for that. I’m sorry that the President didn’t slam back the craven Mr. Reid and pull his upper lip over the top of his head. Fuck Las Vegas and fuck Nevada, and fuck all the casino operators in every pulsating gambling venue around this country. The last thing we need is to continue believing that it is possible to get something for nothing, or an industry based on that false principle. I’d go a lot further and shut down legalized gambling all over the USA, send it back to the margins, to the alleys, to the berm between the WalMart and the Target Store, to the basement boiler rooms, to the public bathrooms, to wherever it will be identified as indecent, shameful, and not healthy.

      Notice, by the way, that the Tea Party people have never made an issue about the disgusting gambling "industry" — not even the Jesus thumpers among them, for all their pretense about decency and propriety. I suppose this is precisely because a cardinal article of Tea Party faith is that it should be possible to get something for nothing. You should be entitled to collect social security even while you inveigh against the intrusion of big government into your life and the horrible prospect that it will get its mitts on your Medicare! And when Jeezus comes to take you home, that place will be just like Opryland USA was in its heyday, with Dolly Parton in every suite and all the pulled pork sandwiches under heaven’s dome….

     As the contest heats up this year between Tea Partydom and the Weimar-like remnant of the party in power expect to see a political vortex form that will suck the little remaining coherence out of American life. Personally, I’d like to see Mr. Obama have a little fun with his adversaries, even if it seals his fate as a one-term president.  I’d like to see him start by using the just-proposed national forum on health care reform as a rope-a-dope moment to expose opponents to reform as the bought-and-sold errand boys they are.

    In the meantime, it appears that nothing will stop the epochal forces underway in global finance from spinning out of control. Illusions are getting hammered hard now and nations are lining up for the long trip home out of modernity to something that will look more like the seventeenth century, if they’re lucky.