The ECB thing

The inquiry:

This is what I've gotten so far... let me know if this makes sense. 

The gist is that the central banks of the world, implored no doubt by the ECB, intend to create programs to allow banks cheaper access to short term USD funding.  The ECB already does this but will now extend the duration of their loans.  One of the concerns the ECB is juggling has been the pending liquidity crunch in Eurobanks holding a ton of bad Sov. paper.  These banks haven't been able to access repo funding markets at rates that weren't damaging their already fragile capital levels (leverage was so 2007... right?... right?... oh...) so the central banks of the developed world have essentially colluded to provide funding at rates and durations at which the free capital markets would not provide.  I am not clear on the time frames here...

WWB response:

The ECB does not have enough liquidity or capital to replace the US$ liquidity lost by the euro banks… that to include the Euro and US repo markets; the ECD markets; the ECP markets; and the USCP markets (probably not available for euro banks now I suspect (hit CP GO for a look) or if it is it won’t be next week). One questions whether the ECB + Germany + France + Othereuro + [limited?] US support is adequate.

So, the US Treasury, Fed and few remaining semi- solvent euro sovereigns are probably funding for now the Euro Central Bank via some non-visible means like private gold loans or swap lines of various types or other undisclosed transactions, this a bridge to the unstated & unknown Uber plan… a mega GLOBAL TARP, a liquidity facility underwritten by undercapitalized sovereigns to prop up the Euro banks with no capital and a boatload of bad sovereign debt.   

The reason you can’t conceive of how it works or makes sense is that it doesn’t. It cannot work unless Germany, France and all the others including the US all play for size (recall the word “overwhelming” by Timmy G, you know the fellow who said there was "no risk" of a downgrade for the US?). You are thinking, "no way US taxpayers would support committing of huge amounts of scarce US (read that taxpayer) capital to such a venture!"

Consider that Timmy G, Fed, and Treasury are not concerned with that quaint notion. It is likely we're already in for size, such and duration to be expanded and defined later. Since it's election time, and Congressional inactivity is always a good thing, how about a Congressional hearing? A little transparency on swap or currency line usage or risk limits? 

Back to the ECB thing. This is the final rounds of injecting CTBPApynm (Capital To Be Pissed Away, perferably yours, not mine) before the euro thing likely grinds to a halt. 

They may have bought some time … a few weeks, possibly days, or months (who knows since there is no disclosure of the means, magnitude, or duration of the temporary support)… to raise capital for the banks which, if successful, will also be CTBPA. 

So,

1. inject temporary capital
2. threaten negotiate with Euroland
3. hope you can get out
4. discover you can’t
5. repeat 

Repeat, that is, until the a) viable sovereigns (France & Germany & some US) go all-in or b) until you hear “BLAMMO” which will be the sound of serial Euro bank failures working their way up the collateral base, which will be insufficient. In the latter case, the losses will be realized by commercial entities and specific sovereigns to the fullest extent possible. Those sovereigns will then default or restructure because they’re broke and also have no access.  In the former case, the standards of living will decrease by a significant multiple of the unrealized losses. Think of that as a reverse, large scale negative Keynesian multiplier less further large scale costs for friction, agency, and corruption.

Update on Saturday, October 1, 2011 at 05:48AM by hb

The WSJ explains the ESFS. What is the sound of one hand clapping? Of one flipper flopping?

A Time to Choose

Thanks to the folks from Zero Hedge for bringing Ronald Reagan's speech "A Time to Choose" to our attention. It is a must watch.  We confess to a bit of copycatting, but we want it to go viral.

We agree with ZH's observation that it is eerie how the conditions and issues in 1964, some half a century ago, directly parallel those that we face today. What is quite different, particularly in contrast to the Republican debate of last night ... and we stipulate a purposely stilted format and importunate hosts, 'braying' does come to mind...is Reagan's effectiveness of language & presentation in connecting a cohesive framework of thought.

We encourage the younger crowd to consider the research for this speech in a proper historical context: this was before the internet. This may in turn place the substance & intent of the criticism of Reagan as ~a mere actor, a dumb cowboy~ in proper context and intent.

We suppose we should write something about investing or the market, but in the meantime and given the degree of control the government has over our economies, we encourage all to consider this speech. We're channelling the very same issues today but our station is such that the costs are so large and the consequences so grave they can no longer be hidden.

Worth a look if you don't know the technicals

This talk on algorhythms is worth a look, particularly the aspect on predictive models for consumer behavior.

Watson Wilkins & Brown, LLC, on the debt deal

What has changed with the new debt deal?

In the debt deal we had a large scale and global demonstration that there is a fundamental, costly, and cumulative flaw in the governance process of the US. One suspects that very few people actually understand the magnitude of the problems of our debt, unfunded liabilities, and increasing macro-economic drag of the costs of regulation.

I don’t buy the notion that the debt ceiling deal is a model of American republican democracy at work.  To the contrary: it is emblematic of the problem. We don’t know if we want to be a market economy driven by innovation and freedom or a socialist economy driven by redistribution of wealth. 

The markets know that and are just going to hang out and price in, every day, the continuing drag of opportunity cost and inefficiency, until we get the major question sorted out.

As it stands now, citizens shall soon lack even the ability to buy an incandescent light bulb. This, perhaps a small thing, but one that diminishes that Shining City on the Hill.

Won’t it save the AAA ratings? Are AAA ratings important to the US?

Let me answer your question with a question. What was the economic value of the enterprise of the United States three weeks ago?  What will it be three weeks from today? The answer to both is about the same as it is today, maybe a bit less, maybe a bit more.

What do we know today that we didn’t know before? Well, we know that Lisa Jackson thinks that under the Clean Air Act "For every $1 we have spent, we have gotten $40 of benefits in return. So you can say what you want about EPA's business sense. We know how to get a return on our investment…" and that this ethos, certainly not logic, remains a driving force behind our national policies that drive capital formation, investment, and employment. There are manifold examples of other continuing policies of the administration that are even more destructive of economic opportunity which we leave to others to explore.

We boldly predict the AAA ratings of the US will not hold because we have too much debt and a decreasing ability and willingness to pay it off. The ratings are largely irrelevant except as an indicator of long term economic & cultural decay. They may be seen as an accumulation of bad policy, bad political decisions rendered by the voters, and poor leadership over time.

We do note that even if we are wrong on the ratings call, we will be right in this ken: recall GM’s paper trading at junk levels in the capital markets while carrying investment grade ratings all around?  As a capital markets issue, generally, the rating agencies are irrelevant. They are generally behind the game and even if they understand the credit, which sometimes they don’t.  And by the way, aren’t the agencies regulated as deemed systemically important institutions?

The capital markets price credit risk every day. Go look.  Last count there were about 65 entities trading better in the markets than the US government.  Probably more today.

How will this be fixed?

People will vote in November 2012.

We have to decide whether we want to be a market & innovation driven economy or an economy based on redistribution of declining stocks of wealth. Productive people and capital will decide whether to stay or go elsewhere.

In the meantime the debt will compound, the spending will compound, the demographics of the country will age, domestic capital formation will stagnate, investment will decrease, interest rates will go up (barring another recession), and investors will look for ways to mitigate financial & regulatory oppression.

How will the market be changed by this deal?

I don’t know, but this is one of the few times in modern history when retail and large scale institutional investors may come close to informational parity, largely due to the complete unpredictability of political outcomes, the lack of enforceability of political contracts (will the SOB’s do what they promise?), and the now increasingly valid questions about the sustainability of rule of law in the US.

Try to allocate capital to create wealth in that environment.

Go hire a Wall Street law firm and ask about the certainty of senior secured creditors’ rights in “systemically” important credits, like Chrysler or GM or GE. Or compare the answers to “What do you think about the possibility of something big & bad happening in the markets?”  A quant geek will talk about six sigma events, kurtosis and the like, while Joe Everyman will say, “Sure seems more likely”.  Which can you take to the bank?  And meanwhile, some Wall Street analyst demonstrates complete dis-utility while bleating that XYZ Company is $.01 over expected EPS. No one cares.

No one cares because it does not solve the problem.

Is the debt ceiling deal good thing?

No, not really. In one sense it is very destructive because it perpetuates the language and manner of a continuing fraud on the American people … by that I mean the entire construct of disinformation where by common meaning and reference are inverted and no longer have validity.  Disinformation & newspeak are working.

Material liabilities are hidden, off budget, and off balance sheet. Taxes are no longer called taxes, but ‘revenues’ and tax reductions are not tax reductions but ‘tax expenditures’. Reductions are not real reductions but reductions from some fictional abstraction called a Baseline which has no relation to actual spending except to facilitate more of it.  Debt limits don’t limit debt, but provide a forum for an increase in debt. "Investments" are not investments, but political allocation of scarce capital resouces away from highest & best use. The government wants to invest in a high speed train, you want to invest in your kid's college education. Your personal priorities as to how you want to allocate your resources count less and less every day. Same with corporations, it just takes a different form.

So we are where our governance has delivered us. No one should be surprised at bad outcomes. Most know that if an entity repeatedly consumes rather than invests, it doesn't work. Or if an entity makes lots of bad, over leveraged investments over time, it doesn't work. 

More problematic is that no one believes the process or manner of conduct of the game is effective or reputable anymore. A friend commented “I don’t know what can be done to get these guys into reality”. The reality of the political class is different: they are in the wealth transfer business, not the wealth creation business.

They are in the business of monetizing their ability to dispense economic privilege to their preferred constituencies, the costs of which are huge & borne by all of us. They extract a variety of personal commissions in currencies that are mostly alien to those in the commercial world (extortions, soft emoluments of political votes or payments for economic privilege, power or other) and create macro costs that are huge & real, but kind of hidden.  

The target has always been other peoples’ money, but now the incremental drag on GDP and force of unsustainable leverage has upped the urgency: “I’m out of money. Give me yours.”

The target is other peoples’ money, and it is a target rich environment … your firm's money, your money, your parent’s money, your kids’ money.

Tell them no.

What is your economic outlook?

WWB are not economists, and we generally don’t fare well in any forecasting. But you asked, so … from our perspective, we just locked in a huge cloud of uncertainty across all dimensions of the US economy until well after the 2012 election. That uncertainty will be transmitted to global economies.

Look for nominal growth of 0%<GDP<2%, if not a few quarters of negative numbers. We expect employment will flatline, go sideways to nominally up, but would not be surprised to see that too go negative from time to time.  We anticipate corporate capital budgets will be trimmed, limited to only near term high certainty payoffs or strategically important or competitively disruptive initiatives. Emerging markets may continue to attract new capital investments on the margin, but that goes away in a heartbeat if corporations see uncertainty in global demand: “Who shall buy these widgets?” And that likely happened today.

So our takeaway

• Liquidity first, long term investment second. We could be sideways for a while.
• Diversification & risk parameters run the book.
• Now is not a good time to reach for higher expected returns or yield ("never" is a good time to reach for yield)
• If you think you have a good macro bead on what happening, you’re likely wrong.

Look for some more big volatility, perhaps some Europigbanks go boom and get nationalized … again … and then it’s going to get really quiet. Volatility will vanish, but it will be the scary kind of quiet, when absence of volatility indicates fear.  People will have their risk books tucked away. Volatility will drop because nothing will be happening.   

The Fed’s out of ammo.  The banks are out of capital. The government’s broke. The language is false. Prices are unreliable. Things get quiet during a rebuild.  Standards of living decline. It’s a grim business, and it's slow.

Where we go from there is the issue.

If you believe that the US will be a market driven economy, equities actually look good if you have staying power.  Private investment in wealth creating businesses (non-listed, low/no regulation risk) will be increasingly more attractive IF there is a restoration of rule of law, contract rights, and sensible regulatory costs.

If you believe that the US will devolve more completely into a redistributionist economy, gold, diamonds and portables look good as do opportunities in the black market. The alternative will be to join Jeff Imeldt on the President’s Council on Employment or get a job with the government. FDIC and FINRA will be hiring. 

I’d personally not bank on the shovel ready stuff: it might be a while. So the short answer is that we have to wait until the elections for clarity and then probably another year after that to even have a clue.

8/3/11

Update on Saturday, August 6, 2011 at 04:46PM by hb

Note the date of our posting.  The downgrade report of Aug. 5, 2011, by Standard & Poors is here:

United States of America Long-Term Rating Lowered To 'AA+' On Political Risks And Rising Debt Burden; Outlook Negative

Rating Lowered                                                                                To                                             From

United States of America (Unsolicited Ratings)

Federal Reserve System (Unsolicited Ratings)

Federal Reserve Bank of New York (Unsolicited Ratings)

Sovereign Credit Rating                                                                    AA+/Negative/A-1+               AAA/Watch Neg/A-1+

It is the responsibility of leadership to solve problems. Part of that responsibility entails bringing attention, forcing attention and resources to solve critical problems. So, if the house is on fire, you call the fire department.

We call for Tim Geithner's resignation.

Update on Monday, August 8, 2011 at 09:18AM by hb

Standard & Poor’s Clarifies Assumption Used On Discretionary Spending

S&P used the Alternative Fiscal Scenario of the nonpartisan Congressional Budget Office (CBO) and Treasury and the administration are characterizing this as a "mistake".  Hmmm... credit judgement or mistake? It would be one thing if Treasury had any credibility. Perhaps S&P was using Turbo Tax?

Here's the fine print on that one:

The Alternative Fiscal Scenario

The budget outlook is much bleaker under the alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. Most important are the assumptions about revenues: that the tax cuts enacted since 2001 and extended most recently in 2010 will be extended; that the reach of the alternative minimum tax will be restrained to stay close to its historical extent; and that over the longer run, tax law will evolve further so that revenues remain near their historical average of 18 percent of GDP. This scenario also incorporates assumptions that Medicare’s payment rates for physicians will remain at current levels (rather than declining by about a third, as under current law) and that some policies enacted in the March 2010 health care legislation to restrain growth in federal health care spending will not continue in effect after 2021. In addition, the alternative scenario includes an assumption that spending on activities other than the major mandatory health care programs, Social Security, and interest on the debt will not fall quite as low as under the extended-baseline scenario, although it will still fall to its lowest level (relative to GDP) since before World War II.

In case you were wondering

This sent in from London by an institutional credit salesperson, a friend and former colleague.

A Visualization of United States debt

We have not verified the analysis, but thought it intriguing enough to share.

Update on Wednesday, July 27, 2011 at 08:23AM by hb

And let us quote from today's (7/27/11) Rates Strategy ! Treasury Morning Call of William O'Donnell of RBS (Royal Bank of Scotland).

•       "Secondly, this link was given to me by a friend in Asia and it will help to "frame" the debt ceiling debate: http://www.wtfnoway.com/  ..."
  

We stipulate the link has been making the rounds, but we're feeling a bit snippy this morning so we'll leave to our readers the assessment of the quality, timeliness, insight & hygiene eminating from capital constrained, self liquidating, opaquely risk stuffed financials owned by distressed soverign states.

Where's my state? Or a helpful retirement guide...

We thought we'd share this graph from The Revenue Demands of Public Employee Pension Promises of June 2011 by Robert Novy-Marx, University of Rochester, and Joshua D. Rauh, Kellogg School of Management.

This work is timely and a hugely beneficial public service, so share it with your friends. Everyone seems to be fascinated by the picture that shows by state unfunded pension liabilities plotted against municipal debt, both as a % of Gross State Product which we present below: 

Anecdotally, we report a general preference by viewers, quelle surprise, for the lower left quadrant. Our sample is biased, if not entirely limited, to tax payers, and we haven't gotten to any state representatives or members of Congress ... yet.

We also note the co-ordinates of the center mass as estimated by blink test seems to be around [17%,17%]. So if we restate the financials to include All Actual Adjusted for Undervalued  & Inaccurately Disclosed liabilites (AAAUID) we get the center mass at effectively 34% AAUID liabilities to Gross State Product. As a proxy that puts them in good company with Nepal, Bolivia, Democratic Republic of Congo and New Zealand as you can see here (we stipulate imperfect method, but it's close enough for government work, eh?).

We ask: why are the material liabilities of states and municipalities in need of ABO adjustments? The authors state 

Plan actuaries typically assume that the expected return on their portfolios will be about 8 percent, and then measure the adequacy of assets to meet liabilities based on that expected return. This accounting standard sets up a false equivalence between relatively certain pension payments and the much less certain outcome of a risky investment portfolio..

We might suggest that an expected return of 8% might be a tad aggressive when the 10 year Treasury is yielding 2.91%? Are we to infer they are all in on equites and leveraged 'alternative assets"? There is clearly a material failure of accurate disclosure and financial reporting here. Where is the Government Accounting Standards Board (GASB)? Where is the SEC? This is how we made the mortgage and financial crisis, and no surprise it's moved to the muni sector.

Wish list: what we'd really like to see is the graph with a few more dimensions, at minimum a surface, adding total state tax burden... and perhaps regulatory cost of compliance.

All in all, great work by these guys. 

Update on Sunday, July 17, 2011 at 07:04PM by hb

Question: May I ask for a specific clarification on Appendix Figure 2: Pension Debt and Non-Pension Debt are Complements (as below)?  How is the ABO calculated in this chart?  Is the method the same as earlier described in the paper …  “we use real Treasury yields (based on TIPS) to discount deflated cash flows, rather than nominal Treasury yields to discount nominal cash flows…” ?

Answer: yes. So in plain English, take the nominal pension liabilities (what the actuaries give you), then deflate them to convert to the nominal liabilities to real liabilities, then discount the real liabilities at the real Treasury rate. 

“greek finance building on fire. euro to new highs. twilight zone”

Thus commented a young trader on 6/29/11. We took it for our cover quote on our Q2 2011 market commentary of 6/30/11 some of which is excerpted below.

• The quote reflects the ‘fog of war’ in the global markets. Anticipate more.
• We see a challenge to Western democratic capitalism as sovereign credits have melded with financials. The deterioration of both is a function of sustained failures of ethical leadership, agency risk, and governance. Economic mis-management of such scale poses a particular challenge to the market oriented, republican democracy of the United States.
• Our circles believe that we have moved well past a crisis of confidence.
• Europe will continue to muddle through the Greek restructuring with Portugal and Spain to follow, and we anticipate the standard of living in Euroland will slowly and ever so surely decline over time.
• We leave to you to assess the probable outcomes of Congress meddling with the primal forces of the tax code & budget priorities. The menu as we see it comprises
  • a default, either technical or substantive;
  • a quick & bad fix; or
  • a good & substantive fix.
• We haven’t even mentioned the elections…except to say we encourage all investors to get directly involved.
• We don’t know whether the last minute 400 or so point run in the Dow was driven by hedge funds trying to drive up Q2 performance (as was suggested by a manager of a $1 bn fund) or whether the market is starting to price in some probability of favorable changes in policy & governance. Champagne uncorking on rumors of Geithner’s resignation?
• We  confess we don’t have a cohesive view of where the markets are going and will not apologize for it. We sense that uncertainty is great, but stand contradicted by relatively low volatility. VIX has taken the role of a contra indicator?
• We remain biased against US$ duration as a function of risk & magic by ‘the Bernanke’ . We still see some value in credit spreads as a defensive fixed income play (“well, its not equity…”). The yield on short term investment grade corporate debt (VCSH, ~2.8 duration) exceeded the 5 yr. Treasury of June 27 by ~ .40%.
• The yield on the Dow (DIA) is about equal to the 7 yr. Treasury and ~12x forecast earnings, not unattractive.

In the main, however, major risk now takes the form of a known unknown (we know we don’t know it): the outcome of political process of regulatory, tax & budget reform. We must note the extraordinary volatility of the 5 year Treasury yield and offer our condolences to anyone who had the temerity to be long on June 26 or 27. 

Lastly, just to keep you sleeping well, was there a leak in the informational pipeline in advance of the downgrade of Portugal that moved the market?  Welcome to the Twilight Zone.

No mas! I’ll take #1, Monty!

Updated on Wednesday, June 15, 2011 at 08:51AM by hb

"Every normal man must be tempted, at times, to spit on his hands, hoist the black flag, and begin slitting throats." — H.L. Mencken (Prejudices: First Series)

We have arrived. We encourage other citizens and investors to arrive as well. We call for no increase whatsoever in the federal debt limit. We call for scheduled real reductions in the aggregate consumption by state, local, and federal government of GDP.  We believe that we are nearing the point where time is of the essence  and further believe in the necessity of enlisting the discipline of the capital markets to achieve that objective.  If the political circumstances require a technical or substantive default to invoke the discipline of the capital markets, so be it.

No more kicking the country’s can down the road. Fix it now. This posting has been simmering for a while, and the catalyst for publication, perhaps prematurely so, was Larry Summer’s article in the June 13^th edition of the Financial Times, How We Can Avoid Stumbling Into Our Own Lost Decade.  His thesis, reductively put, is an infinite do-loop,

Click to read more ...

Get your health care waivers here!

In case you are wondering, here is the list of health insurance waivers granted so far.  The length of the list evidences non trivial economic value.   Let's think about that for a minute...?

In any case if you'd like to get your very own, give it a go here! 

Yes, you can! Or maybe not.

US Gross Debt as % of Gross Domestic Product

Source: FRED, Gross Federal Debt (FYGFD), Annual, Fiscal Year and Gross Domestic Product

This data series series did not include Q1 2011 data at time of posting.

A Chinese view of sovereign credit risk & solvency

Updated on Thursday, March 31, 2011 at 01:51PM by hb

The Dagong Global Credit Rating Co. Ltd. is a credit rating and risk analysis research institution founded in 1994 upon the joint approval of People‘s Bank of China and the former State Economic & Trade Commission,  People’s Republic of China. Think of it as an informational and policy utility.

They have published their 2011 Sovereign Credit Risk Outlook which contains important perspectives, that is if one chooses to listen to one's investor base. It's an interesting document in it's own right, and highlights with some liberties follow:

Review of 2010

1. The credit quality and in some cases solvency of key developed debtor countries declined sharply
2. They accuse the United States, "the world's largest debtor country" of waging "global credit warfare"presumably by excessive monetary expansion (printing money) and excessive debt issuance. One infers that they appropriately fear a declining US$, a rising Yuan, and an inflationary collapse of the US bond prices, in essence a devaluing of their holdings.

Click to read more ...

The USA as a business: say it with pictures

Kudos to Ms. Mary Meeker and her firm, Kleiner Perkins Caufield & Byers. They have done a public service by putting together a comprehensive analysis, USA Inc., that tries to answer the question, "What if we looked at our country as a business and applied some related analytics & disciplines?"  I only wish it had gotten more visibility.

Some of the analysis is compelling, and stunningly, much of this basic data is simply not surfacing from the imbecilic cacophony of mugwumps in media, policy or politics. We can understand why the politicians don't want these pictures to see the light of day. Broad understanding would reveal the great unpleasantness and failure of political leadership that brought us here. They communicate quite clearly what our problems are.

Entitlements alone consume nearly all revenue, and it will get dramatically worse going forward:

Our balance sheet is fraudulent in that it does not disclose all liabilities. When we put those liabilities on the balance sheet we become book insolvent. So the next time a politician says the words "trust fund" make sure that he means that an independent, non-governmental third party trustee will hold the funds for your benefit.

And our debt outstanding only reflects what's the on balance sheet!  Through the wisdom of governmental accounting orange stuff above isn't reported as a real obligation on the balance sheet! In the private sector this omission would be garden variety 10(b)(5) fraud but as Marilyn Monroe once said, "It's different for girls..." so when you start thinking about the debt crisis, don't forget to put the orange stuff on the balance sheet.  The omission is a fraud: a game of 'Hide the ball' that government has played so long. Game over.

 Lastly, while we're spending a lot on defense it does not appear to be out of line historically.

Spend some time with the study & share it with fellow citizens. I'm not buying into all the recommendations as some obvious private sector solutions have been given short shrift (more on that later), but defining the problem is a first step to solving anything.

For context of the magnitude of this problem consider that: 

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits

And folks, that's the home team voting with their feet.

Update on Tuesday, July 19, 2011 at 10:31AM by hb

We're flattered to see WWB's Commentary leading the way for the WSJ, and note the date of their article today: America's Debt-Ceiling Opportunity by Emil Henry. 

Let's think about this: a good and free example

WWB states it's bias in favor of beta driven returns and longer term asset allocations (i.e. construct portfolios of various asset classes and execute through low cost indexed product). Of course, this approach is based on a variety of assumptions, and it is certainly possible, if not probable, that some assumptions vary as to degrees of reliability or confidence over time and circumstance.

We do not live or invest in a perfect world.  There are limits to information and analytic & computational capacity, and it is unlikely that any retail or small institutional investors are anywhere near them. We would argue that most medium to large institutions are nowhere near them.

Here's a good and free example  of the lower end of what's available. Here Google Domestic Trends charts the number of web inquiries against DAL.  We stipulate it's pretty cool, but bear in mind this is so primitive, its free ... the lowest grade of analytics available. And what you do with this is not clear: do rising inquiries foretell more passenger/miles? Or a change in consumer elasticity providing less revenue/mile/passenger? Does cancer cause smoking or vice versa?

I recall a hedge fund manager once showing me a similiar chart of entirely different variables. He closed his presentation with "It's a no brainer. I can trade that. Anyone can trade that."  Perhaps, but nevertheless we declined to pay him for the priviledge of testing his hypothesis with our money and granting fees that vested as his call option with asymetrical treatment of our downside risk (heads I win, tails you lose). 

The next time you want to buy an individual security, think about this example, but extend it to every asset class and security around the globe and do it on a real time basis. What do you know that everybody else doesn't? If you don't have a good, hard, and legal answer to that question, you'd better worry about the converse.

As one of our associates commented in a strategy discussion as to the state of analytics and theory, "Look we know that Newtonian physics don't work all the time, but it's pretty tough to build a bridge without them."  And we are looking to build bridges, if not bombshelters, across which we, our families, and clients, can walk.

Lastly, who do you think has better information? Google or the Fed? Hmmm....

Swiss reject Irish government debt as valid collateral

The Swiss National Bank (SNB) will no longer accept Irish government debt, and that of several of the country's major lenders, in its repo operations. This is a significant adverse credit judgement. We look for others to follow and ultimately other weak countries will be added to the list. Some one will have to finance this stuff... just not the Swiss.

Evidently, the Swiss do not see their primary role as protecting the Irish government or selected Irish banks from the consequences of bad policy. 

"You just made the list, buddy" -  Francis, aka Pyscho, in the movie Stripes

European nations start to confiscate private pensions

The Adam Smith Institute reports that European nations have started to sieze private pension assets: Hungary, Poland, Ireland, and Bulgaria have all joined the party, although by slightly different means. It is an example of financial oppression of citizens by governments. 

This is a preview of coming events in the US. One suspects that given the massive underfunding of many state & municipal pensions and the pending insolvency financial stress of various municipalities & states, politicians will give it a go. 

Morgan Stanley put a bold warning in the public domain and to their credit used the exact words, "financial oppression" which we noted in our posting The Last Chance Saloon of Sept. 1, 2010. They were spot on. The trend will accelerate in Europe where portable assets & black markets will soon trade at an even higher premium. 

The US political class will face a hard choice: non-trivial real reductions in transfer payments and government spending or take a shot at this kind of oppression. 

These economic wheels grind slowly, but very finely. Watch your exposure to the estate and effective marginal tax rates at the state & national levels.

More than half of the Fed's Term Auction Facility went to foreign banks

The Financial Times reports today that more than half of the TAF went to foreign banks. It was an outright transfer of wealth from US tax payers to foreign banks (excerpted below):

Ed Clark, TD chief executive, said that using Taf was logical even though his bank never had a liquidity problem. “That wasn’t how we made a lot of money. But you make a dollar here, you make a dollar there. What’s the spread you make on a billion dollars?” he said.

In the summer of 2008, TD was borrowing $1bn from TAF at rates of between 2 and 2.5 per cent. For that borrowing it used the lowest quality – and hence highest yielding – collateral acceptable to the Fed.

More than 80 per cent of its collateral had a triple B credit rating at a time when such bonds yielded about 7 per cent. TD could therefore have made a notional gross spread of about $4m a month during 2008.

Mr Clark said the authorities were encouraging healthy banks to use schemes such as the Taf so as not to stigmatise their weaker counterparts. In January 2008, Ben Bernanke, the Fed chairman, said the Taf appeared to be succeeding because “there appears to have been little if any stigma”.

“You go through the whole crisis and there were lots of things we did that weren’t necessarily economic but were the right thing to do for the system,” said Mr Clark. “So I’m not embarrassed by this at all.”

One presumes not, given that Mr. Clark played by the Fed's rules, but the Fed has no such cover. It ought to be embarrassed.  The US taxpayer lent at 7% to non-US AAA rated banks (or banks including RABO) based on putatively BBB quality collateral.  And presumably the collateral were paying cash. This wasn't however a loan: it was the provision of contingent equity capital to foreign banks (Canadian, European and Asian) for no consideration, all courtesy of the US taxpayers.

WWB understands bank liquidity, solvency, and systemic risk. All should know that the melding of sovereign and trans national bank risk leads to reckless underwriting (QED), more risk, and then to a vitiation of contract & property rights and ultimately to democracy itself. Managing systemic risk is not hard, but you have to forgo some of the social agenda that has been attached to it. If you want to reduce systemic risk, break it down into its components and start taking them off the table, piece by moral hazard piece.

The alternative is to manage systemic risk as the Fed has done, and apparently will continue to do, by aggregating it into larger and larger amalgamations of undefined, hence unmanageable, risk structured as an uber asymetrical option in favor of rent seeking financial institutions and underwritten by the taxpayer. And all US taxpayers know what that means: "Heads, I win. Tails, you lose."

Lastly, if gas hits $5/gallon in 2012 as the former President of Shell Oil today predicts, will the energy sector be declared to pose a systemic risk under Dodd-Frank? Well, are volatility and duration the primary drivers of option value?

If you're looking for a primer on municipal finance & bankruptcy...

Look no further: Fiscal Stress Faced by Local Governments of December 2010 by the Congressional Budget Office is a good summary of the state of affairs.  One might read portions of it to be constructively supportive of bankruptcy as an option in many instances. Coming soon to a theatre near you...

Make sure you know what you own.

Maybe the Fed doesn't have Yahoo or Google finance?

Here we see the price behavior over the last 3 months of certain proxies of asset classes of interest:

• energy (via the proxies XOM and OIL),
• precious metals (GLD and SLV);
• commodities (GSG),
• 30 yr US Treasury yield (^TYN); and 
• US $/EURO rate (EURUSD).

Those of us who are color blind may have difficulty discerning the finer points, but in some sense the colors don't matter. The blink test is sufficient. Annualize the gains, and you get some non-trivial numbers.  

The only things going down are the US $ and the credibility of the Fed. Oh, we forgot, short US interest rates too ... with thanks to Johannes Gensfleisch zur Laden zum Gutenberg who invented the essence but not the jargon of 'quantitative easing'.

We have, once again, Nassim Taleb tearing a very public and much deserved strip off Bernanke (its worth the full viewing), and Bill Gross in Run Turkey Run uses the failing credibilty of the Fed to induce fear:

Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme.

which Gross then turns into a marketing ploy:

We hope to be your global investment authority for a new era of “SAFE spread” with lower interest rate duration and price risk, and still reasonably high potential returns. For us, and hopefully you, Turkey Day may have to be postponed indefinitely.

Oh, my.  We don't necessarily disagree with his analysis, but find the style a little heavy handed... but that was before the Asian finance ministers cut loose with the 12 guage OO buck shot.

The spread between nominal bonds and TIPS (inflation indexed bonds) is a quick proxy for inflation expectations, and we note the same trend as the picture above:

 10 year constant maturity treasuries less 10 year TIPS:

Of course, over the weekend, right in the middle of this drafting, all hell broke loose in a Fresh Attack on Fed Move . 

The good news, though perhaps not for the Fed, is that important new independent sources of inflation data are making their way into the public arena.  Wal-Mart's data would appear to be more current than the Fed's and reflective of actual sales to the consumer:

A new pricing survey of products sold at the world’s largest retailer  [WMT  53.99    -0.14  (-0.26%)   ]  showed a 0.6 percent price increase in just the last two months, according to MKM Partners. At that rate, prices would be close to four percent higher a year from now, double the Fed’s mandate. Source: http://www.cnbc.com/id/40135092 

Meanwhile the Financial Times reports Google to map inflation using web data  We have every expectation that whatever eventuates from this initiative will be better, faster, cheaper, more precise, and, dare we say, potentially less biased, than the Fed's. Call it a measure of  just in time inflation...

We confessed our bias to short duration some time ago and suggest everyone watch the 10 year Treasury. We suspect there will be some credit turbulence in Europe.  Let's just hope it stays there. Pending sensible resolution of some of the major fiscal, trade & regulatory issues, there is still a fair amount of risk that could quickly compound or boomerang. We don't believe the nominal rise in equities is a panacea, although we'll take it, and we think there is still a fair bit of political & policy risk implicit in  these price levels.

If the Fed and Congress have gotten a whiff of the smelling salts, it will have been a good start. One suspects the Fed has already damaged its credibility, and if they keep pushing the Gutenberg agenda as a proxy for the failure of tax and fiscal policy, the public may very well ask the bald question: "Why do we need more monkeys throwing darts?"

GM and friends of Angelo

The WSJ writes in China's SAIC Finalizing Plans to Buy GM Stake:

The issue of foreign investors buying GM shares in the company's IPO is a sensitive one for the U.S. government, which will reduce its 61% stake in the auto maker in the IPO. Treasury also is worried about the political reaction if non-U.S. investors, such as sovereign-wealth funds or a Chinese company, are allowed to acquire a significant stake in GM after U.S. taxpayers spent $50 billion to assist the company through bankruptcy reorganization.

But like everything else with a government deal lately, you have to read the fine print and follow the money. The allocation of the IPO is just one of the long line of wealth transfers in this process, and the list and process by which it was managed should be made public. The list of sovereign investment funds and now familiar large domestic institutions would be of interest. One suspects the IPO will be carefully staged, dramatically under priced, such that it has an initial pop, thus pumped as a huge success.  Who gets the money? Check the allocation. If it does pop, you know the taxpayer has been shorted for the sake of publicity.

if that happens, it would be good news for the Obama administration, which could find itself under fire for pricing the deal too low—thus shortchanging taxpayers—if GM's post-IPO price rises sharply after the offering.

Last we heard the retail shops, the Schwabs, AmeriTrades et al, were shut out. One wonders why... perhaps if you want your ticket punched it should be suitably large and you have to hang around a bit?

The other element to follow the taxpayer's money is the special treatment accorded GM's NOL's, the net loss carry forwards. Typically these are expunged in a bankruptcy, but we understand special treatment allowed them the be carried forward into the new entity which means that the taxpayer subsidy is even greatly understated. If the new entity is profitable, it will likely pay no taxes... just another wealth transfer.

For the record, we don't like the process. We don't like it when it seems the 'fix' is in ...  bought and paid for with taxpayer's money and seemingly manipulated without regard to costs for non-economic outcomes. But that seems old hat these days.

This smells like an Angelo Mozilo friends & family deal. Just watch.

_______________________

Hate to do this, but we need some disclaimers & fine print on this one:

For sake of clarity, this is an opinion, which we urge you to consider as possibly uninformed or misguided, on a process, not a security.  We make no recommendation whatsoever on this particular security nor do we express an opinion of any kind on any particular price and nothing herein shall be so construed.  We have no  position (other than that which may or may not exist in broadly based indexed product) or economic interest in the offering.  We have never subscribed to an IPO and don't intend to start, so we're not sour graping about the allocation. We make no representation or warrantee whatsoever as to the accuracy of any information posted herein. Nothing herein shall be considered to be an offering of any security; an endorsement or recommendation of any particular security; or an opinion or recommendation as to the suitability or appropriateness of any particular investment strategy. WWB does not offer legal or tax advice and nothing herein shall be so construed. No kidding.

Predictive markets: Intrade and the market for Senate control

Update on Monday, November 1, 2010 at 12:00PM by hb

Mid point or last prices. Source: http://www.intrade.com/jsp/intrade/contractSearch/index.jsp?clsID=19&grpID=8627

Update on Wednesday, November 3, 2010 at 07:24PM by hb

The data in the graph was as of approximately 11.15 AM EDT on Nov 1, 2010.  It seems to have been a reliable indicator of the actual outcome.