Sense on Cents

Municipal Finance: Will Uncle Sam Post Bail?

Posted by Larry Doyle on May 26th, 2009 3:09 PM |

Is every village, town, city, and state in our country poised to receive a “get out of jail” free card from Uncle Sam? I linked to The New York Times article, Localities Want U.S. to Support Muni Bonds, in the Newsworthy section of Sense on Cents. Upon further review, it deserves comment.

In my opinion, this support of the municipal market may very well represent the greatest violation of a moral hazard to date. Why? Municipalities are by edict required to balance their budgets. A municipal budget which is able to obviate the tough decisions and choices in the budgetary process will lose that rigor.

Politicians of all stripes will make the case that the municipal default rate is extremely low and, as such, a federal backstop in the form of bond insurance is truly a very low risk proposition. Please allow me to opine that the same argument was made in the quasi-guarantee provided to Freddie Mac and Fannie Mae. Those two giants are now wards of the state having been utilized by politicians from both sides of the aisle as campaign “piggy banks” for the better part of twenty years.

The New York Times highlights that the federal guarantee of municipal debt is not all that Uncle Sam may be asked to bail:

“All kinds of municipal borrowers are facing revenue shortfalls,” said Mr. Decker. “California is the largest example. Some states are better off than others. But all outstanding debt is backed by tax revenues. And municipalities are facing a greater or lesser level of distress.”

Also clamoring for help is a group of municipalities that purchased Lehman debt, which is now nearly worthless. Legislation authorizing the use of relief money to make these purchases was introduced by two California Democratic representatives, Jackie Speier and Anna Eshoo. If approved, this would be more like a bailout than a guarantee, because the federal government would be paying face value for debt that otherwise has little value.

The price tag on that proposal is around $1.6 billion. The argument promoted by the two congresswomen is that the Treasury and Fed allowed Lehman to fail, causing governmental bodies to lose money.

Whether a price tag is $1.6 billion, $1.6 million or $1.6 trillion a potential federal bailout of a poor investment decision is the antithesis of free market capitalism. Where does it end? Read the rest »

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Housing: Cheap and Getting Cheaper

Posted by Larry Doyle on May 26th, 2009 10:59 AM |

housing-market1 The Case-Shiller Home Price Index was released this morning and disappointed with a worse than expected reading of -19% versus a year ago. Relative to the 4th quarter 2008, home prices nationwide are down 7.5%.

Are home prices continuing to decline despite the support of a variety of government programs or perhaps because of them? What do I mean? Any market – whether stocks, bonds, currencies, commodities, or housing – is constantly trying to assess both current and future demand and supply. Potential buyers or investors can most accurately assess the value of an asset when provided with full and accurate information.

In my opinion, our housing market is suffering from the unknown supply of homes – currently involved in a mortgage modification process – that will likely hit the market in the future due to foreclosure. The fact is that the ultimate default rate on many of the homes involved in a mortgage modification is extremely high. As the Wall Street Journal highlights this morning, Mortgage Modifying Fails to Halt Defaults:

A key finding from the Fitch report was that subprime, pooled loans that have been modified are souring at high rates despite a change in the loan terms. Fitch said a conservative projection was that between 65% and 75% of modified subprime loans will fall 60-days or more delinquent within 12 months of the loan change. That finding echoes prior U.S.-bank-regulatory agency reports of high redefault rates for modified loans.

The Fitch report said one reason for the high redefault rate was public pressure to modify loans even for borrowers who were likely to default whether the loan terms were changed or not. Fitch said another cause was falling home prices. Ultimately, these homeowners, deep underwater, walk away from the home, resulting in the redefault of a loan.

The simple fact is a significant percentage of the loans being modified NEVER should have been written in the first place. Modifying these loans merely forestalls the home from being foreclosed and sold. I do not believe government officials have real appreciation that this forestalled supply actually puts further pressure on housing overall. Why? The market is not being allowed to “clear,” a process in which an asset is moved from weaker hands to stronger hands. To wit, I believe we will continue to see ongoing declines in home values on a going forward basis.

A Look at Case-Shiller Numbers as provided by the WSJ:

“The tone of this report was clearly weak, and it comes at a time when markets were beginning to sense and price in (perhaps prematurely so) a stabilization in the U.S. housing market,” said Millan L. B. Mulraine of TD Securities. “Despite the encouraging signs that have been coming from the other housing market reports, we continue to highlight the risks that the correction in the U.S. housing market may continue for some time as the worsening labor market conditions and historically high inventory of unsold homes continue to off-set the favorable affordability conditions.”

That overhang of inventory will be perpetuated via the mortgage modification process. A full numerical chart highlighting the dynamics within respective metro regions is quite interesting. Not sure why Minneapolis is showing the greatest declines. Anybody who can provide color on the situation in MN, it would be deeply appreciated. Away from that, the other locales suffering the greatest declines continue to be in the obvious areas (Detroit, Las Vegas, Phoenix, Miami). Charlotte, Dallas, and Denver are displaying signs of stability.

Please share insights on housing in your region!!

(About the numbers: The Case Shiller indices have a base value of 100 in January 2000. So a current index value of 150 translates to a 50% appreciation rate since January 2000 for a typical home located within the metro market.)

Home Prices, by Metro Area

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Change, Change, Change

Posted by Larry Doyle on May 26th, 2009 7:46 AM |

How are we as a nation handling the changes going on in our country?

Change is stressful, especially when the change is involuntary. The ability to adapt to change is critically important in order to minimize the stress, maximize the opportunities, and move forward in life. The ability to adapt to change and prosper from it is the premise for one of my recommended books in the Sense on Cents Reading Room, Who Moved My Cheese?: An Amazing Way to Deal with Change in Your Work and in Your Life by Spencer Johnson, M.D.

I first read this book in early 2001 prompted by the merger of Chase Manhattan and JP Morgan. Dare I say the changes ongoing in our economy and world render the merger of two large banks rather pedestrian. That said, the lessons in Johnson’s book apply to professional and personal situations. I have recommended this book often.

I was reminded of Johnson’s Who Moved My Cheese? this morning when reading an article in the Financial Times, When Austerity Does Not Come Easily:

When the global economic crisis first hit, it was natural to assume that the poorer and more recent democracies would be most vulnerable to a political backlash.

But perhaps we are looking for trouble in the wrong places. It could be that it will be the richer democracies, such as Britain and the US, that find it most difficult to adapt to the politics of austerity.

While this message is neither pleasant nor easily broached, I truly appreciate it and commend Gideon Rachman for writing about it. In regard to change, our country needs to initially understand, willingly accept, hopefully embrace, and then boldly move forward. I think we are still in the very early stages of the “initially understand” phase.

While the Obama administration has put forth large measures and grand programs under the guise of change, I view many of these measures as “more of the same.” That is, inflated government spending and bureaucracy to facilitate living beyond our means. The simple fact is, a country, corporation, municipality, or individual that perpetually lives with an excessive and growing debt burden is postponing and potentially eliminating the chance for real prosperity.

Market analysts, media mavens, and government officials regularly call for an end to our recession in 2009 and a return to “normal.” I view this time in dramatically different fashion. I believe we are experiencing not only an economic test, but also a test of national character. Read the rest »

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Revisiting a Mad, Mad, Mad, Mad World!!

Posted by Larry Doyle on May 25th, 2009 1:01 PM |

As if we do not have enough issues to deal with here in our own backyard, we are reminded on Memorial Day, of all days, just how mad and unsettling the state of our world happens to be. I broached this theme on April 5th, but recent international events make it prudent to revisit.

While the issues in North Korea and the Middle East deal primarily with military and political conflicts, they most definitely impact our financial markets. How so? Any time we are faced with increased risks of any sort, the markets incorporate them into prices.

Going to the Far East, we encounter Kim Jong Il of North Korea detonating a nuclear bomb. As reported by CNN, World Outraged by North Korea’s Latest Nuke Test. How will Obama and world leaders respond? A bully left unchecked will continue to try to move his sphere of influence:

“North Korea is directly and recklessly challenging the international community,” the White House said. “The danger posed by North Korea’s threatening activities warrants action by the international community.”

While the test was not a surprise, Adm. Mike Mullen, chairman of the Joint Chiefs of Staff, said it showed Pyongyang was becoming “increasingly belligerent.”

Moving into the Middle East, we encounter a cauldron continuing to boil. Reuters reports, Iran Sends Warships to Gulf of Aden:

Iran has sent six warships to international waters, including the Gulf of Aden, to show its ability to confront any foreign threats, its naval commander said on Monday.

Admiral Habibollah Sayyari, quoted by the ISNA news agency, made the announcement five days after Iran said it test-fired a surface-to-surface missile with a range of 2,000 km (1,200 miles), putting Israel and U.S. bases in the area within reach.

Read the rest »

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FHLBs: Red Sea, Dead Sea or Both?

Posted by Larry Doyle on May 25th, 2009 8:46 AM |

On April 2nd, in a post Putting Perfume on a Pig, I compared Freddie Mac, Fannie Mae, and the Federal Home Loan Bank system to the Red Sea. Why? For the very simple reason that for the foreseeable future, these entities will accrue losses. How? Unlike commercial banks, Freddie, Fannie, and their 12 FHLBs have very little earnings power in this environment while faced with a steady stream of losses on their mortgage holdings given ongoing defaults and foreclosures.

In retrospect, would it have been more appropriate to compare the FHLB system to the Dead Sea than the Red Sea? I think it may. As the Wall Street Journal highlights, Directors Are Faulted at Home Loan Banks:

Financial troubles at some of the Federal Home Loan Banks are raising questions about how well directors of these institutions are supervising their executives.

A plunge in the value of mortgage securities bought by several of the regional home-loan banks has forced them to halt dividends and curtail funding for local housing projects. An annual report issued by the banks’ regulator this past week says some of them “paid insufficient attention” to credit risks and haven’t invested enough in information technology.

Unlike giant banks or government-backed mortgage companies Fannie Mae and Freddie Mac, the 12 regional home-loan banks draw little public scrutiny. (LD’s emphasis) Created by Congress in 1932 to support the housing market, they are cooperatives owned by more than 8,000 banks, thrifts, credit unions and insurers.

Why do these home loan banks draw such little public scrutiny? They are the wholesale entity (providing funds) to their retail network (banks, thrifts, credit unions, insurers) which deals with the public. With no interaction with the public, the media and market analysts have accorded them little coverage. Thus, I make the assertion that these banks truly are a combination of both the Red Sea (ongoing losses) and Dead Sea (no coverage). Read the rest »

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NoQuarter Radio’s Sense on Cents with Larry Doyle Will Be Back Next Week

Posted by Larry Doyle on May 24th, 2009 2:00 PM |

In observance of Memorial Day weekend, NQR’s Sense on Cents with Larry Doyle will not be broadcast this evening.

I hope you are able to enjoy the holiday with family and friends while reflecting on the people and values Memorial Day celebrates. We are currently living through historic times, but we can never afford to forget the sacrifices of the special men and women who fought for our freedoms. God bless them.

Even though I will not be broadcasting this evening, if there are any questions or topics you’d like me to address, please do not hesitate to ask.

Thanks for your support!!

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London Calling: LIBOR Revisited and The Greenback

Posted by Larry Doyle on May 24th, 2009 8:27 AM |

The biggest developments in the market and economy this week were the decline in the value of our greenback and the move higher in long term interest rates (10yr U.S. government bonds moved to 3.46%, a level not seen since last Fall).

Despite these concerns, many analysts will point to the drop in Libor (London interbank overnight rate) as an indication of the increased confidence in the global banking system. I strongly disagree.

I believe the drop in Libor is not a reflection of the “fundamental” improvement in our global banking system, but rather a “technical” reflection of the supply of dollars that have been injected into the global economy. There is an enormous difference in these lines of reasoning and the implications they have for our markets and economy going forward.

If Libor were declining because of a “fundamental” improvement in the global banking system, it would be reflected in an increased flow of credit into the economy. That flow is not happening.

If Libor is declining because of a “technical” supply of dollars, then it would be reflected in a decline in the value of the dollar, an increase in long term interest rates, an increase in the prices of select commodities (gold has rebounded to $957/oz, oil is back above $60/barrel), and other inflation-related variables. Yes, we are seeing all of these developments.

Let’s revisit my post from May 15th, What Is Going On With Libor?

While many analysts were promoting the drop in Libor as a positive, I begged to differ and wrote:

Has the drop in Libor coincided with an improvement in the credit markets? No. Despite what pundits would tell you, credit spreads remain at elevated levels. In fact, on an inflation adjusted basis, rates are at the highest levels since the early 1980s.

Why aren’t banks lending as much? Lack of confidence in the economy along with enormous embedded losses in their current book of loans. Those losses are real and will be rising. The elusiveness of bank credit is highlighted in a McClatchy article, Businesses Struggle as Bank Loans Remain Elusive, in the Newsworthy section of Sense on Cents.

Thus, if a drop in Libor is not a reflection of improved credit conditions, what does it mean?

In my opinion, it is a precursor to a drop in the value of the dollar. Why?

Very simply, too many greenbacks floating around. A decline in the value of the dollar is inflationary. Both core rates of producer prices and consumer prices reported this week were higher than expected. I’ll be watching.

Please recall, there are always three factors that determine the level of a market: fundamental, technical, psychological. A move in Libor is almost always analyzed from a fundamental standpoint. However, in our Uncle Sam economy, we need to be increasingly diligent in reviewing all three of the aforementioned factors along with the implications they have for our global markets as we navigate the economic landscape.

P.S. In light of the Memorial Day holiday, I will not be hosting NQR’s Sense on Cents with Larry Doyle this evening. I look forward to getting back at it next week. If you have any questions or topics you would like addressed, please do not hesitate to leave them and I will respond. Enjoy!! LD

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Financial Advisers: “A Crisis of Confidence”

Posted by Larry Doyle on May 23rd, 2009 7:38 PM |

Are you confident in the financial advice you are receiving?

A recent report in InvestmentNews, Financial Advisers Face a Crisis of Confidence, indicates that an overwhelming number of investors are not happy with their financial advisers. In fact:

About 80% of affluent investors — that is, those with more than $500,000 in investible assets — are “disgusted with their adviser because their adviser is spooked,” he said.

Wow!! How is it that such an overwhelming percentage of investors can develop disgust with their adviser? Very simply, as with any service, if you are not getting professional coverage for the fees charged, a level of disgust can easily develop.

Based on my experience, I have dealt with a wide range of professionals in this field. A small percentage are outstanding, a few more are more than satisfactory, a large percentage are decidedly mediocre, and plenty are borderline, if not totally incompetent. I would venture to say the same assessment could be made of many professions. How does this happen?

Financial advisers are primarily trained to do two thngs: sell products to generate commissions and gather assets to generate fees. I have been involved in training programs as participant and adviser. Additionally, I have been solicited more than I care to remember. All too often, I have experienced people and programs geared toward products and services.

Very infrequently have I experienced programs and people that fully understand the dynamics at work in the economy and markets. Additionally, I have very infrequently experienced people who truly care to learn and understand the customer’s needs and how they can help solve the customer’s issues. Why?

The salesperson or adviser is too focused on writing immediate business and moving on to the next sale. What is the result? Read the rest »

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Let’s Cross the Pond and Revisit The Weakest Link

Posted by Larry Doyle on May 23rd, 2009 2:27 PM |

The Washington Post is running a lead article today about the concern that the European Union in general, and the United Kingdom specifically, may derail the global recovery. Let’s cross “the pond.”

European Slump May Stall Global Rebound

Some countries, such as Ireland, are so cash-strapped that they’ve raised taxes in the middle of a deep recession, making things worse. In addition, European leaders have only recently signaled their willingness to conduct broad, systematic stress tests on their financial institutions, similar to the ones on major U.S. banks already concluded by the Treasury Department.

This is not news. Nothing of substance has dramatically changed in Western or Eastern Europe from my writing, The Weakest Link and The Weakest Link Is Weakening in late February and early March.

The media, government officials, and market pundits have been been attempting to talk the economy up more than the actual reality would dictate. The equity markets rebounded from an oversold condition in early March. For short term traders and those focused on technical analysis, I hope you caught the move. For those focused on the long term fundamentals of the economy, the risks remain very high.

While, WaPo and other media outlets may voice concerns now or report developments as new, the “strains in the European chain” remain very real. Along these lines, I had written on April 30th in my April 2009 Market Review: Brave New World:

I believe it is a question of when – not if – in terms of a major European country defaulting on its debt and requiring a rescue from the EU and/or IMF.

The Washington Post should be a little more rigorous in terms of checking their facts. They report:

While U.S. banks have already written down about half the estimated $1.1 trillion in troubled loans and toxic assets on their books, Europe’s financial institutions have thus far written down less than 25 percent of their $1.4 trillion in bad debts related to the crisis, according to a report from the International Monetary Fund.

In actuality, the IMF has forecasted that U.S. banks have upwards of $2.8 trillion in troubled loans and toxic assets and have written down approximately 40-45% of it. That’s bad reporting. At least the reporter is diligent enough to highlight that Western Europe’s major concerns relate to the financial exposure to Eastern Europe. Although, this is not new news, they report:

Many major Western European banks are also heavily invested in hard-hit Eastern Europe, where the risk of a fresh wave of corporate and consumer defaults is considerable.

With all due respect, tell us something we don’t know.

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Sense on Cents On Economy and Markets: Lets Look Back to Look Forward

Posted by Larry Doyle on May 23rd, 2009 8:50 AM |

The developments in our global economy are so large in scale that it is of paramount importance to develop a macro view. David Swensen, Yale’s head of investments and widely regarded as the top portfolio manager within college and university endowments worldwide, says as much in an interview reported by Bloomberg:

“The crisis forces you to think top-down in ways that would, I think, be unproductive in normal circumstances, or absolutely necessary in the midst of a crisis,” Swensen said. “You have to think about the functioning of the credit system. You have to think about the potential impact of monetary policy on markets over the next five or 10 or 15 years.”

I concur. In that spirit, let’s look back at my outlook from last October so that we can more clearly look forward as we navigate the economic landscape.

Excerpts, with current commentary, from The Economy – What Lies Ahead (originally published October 14, 2008):

1. Global Increase in Long Term Interest Rates – the massive amount of debt that will need to be issued will cause rates worldwide to rise even in the face of a likely significant economic slowdown.

I still maintain this premise. The move down in the economy last Fall led to an initial move lower in rates on government bonds. Our central bank and other central banks have subsequently supported the economy via quantitative easing (central bank purchasing of government and mortgage-related assets). That said, we are now entering the stage where the global demand for credit is swamping investors’ and central banks’ ability to provide it and rates are moving higher. I believe this move to higher rates, especially in the government and mortgage sectors, will continue. Rates for municipal and corporate bonds should also be forced higher although not as much.

2. Financial asset deflation while hard goods and asset inflation. Why??
I can already hear the printing presses at work churning out currencies worldwide. The rise in interest rates will depress bond values. With slower worldwide economic growth and increasing unemployment, GDP prospects are not pretty for the foreseeable future. I think there is a very strong chance that we will see “stagflation.”
While financial assets have limited upside growth potential and significant downside even from here, hard commodities and assets will likely increase in value, or perhaps I should write will hold their value as financial currencies and financial assets lose value.

I continue to believe we will experience stagflation. Comments by Bill Gross of Pimco highlighting the potential likelihood of the United States losing its implied AAA credit rating adds fuel to this fire.

Individuals, corporations, and governments still need to delever (pay down debts) and will be forced to sell assets in the process. As such, while I think selected sectors of the equity market may hold up, I remain concerned about the overall market. I think the U.S. dollar and other currencies of overlevered (big fiscal deficits) nations will suffer. These developments are inflationary. To defend one’s portfolio from inflation, gaining exposure to TIPS (Treasury Inflation Protected Securities) is prudent. Mr Swensen addresses this point in the aforementioned interview.

3. Where do you put your money??

Take what the market is giving you, and right now they are giving you security and guarantees in deposits in large money center banks . . . this also provides flexibility to provide liquidity for those in desperate need and you will see more and more of that occur both at a personal level and a corporate level . . . BE PATIENT . . . buy QUALITY . . . this market is very quickly separating the wheat from the chaff . . . well managed institutions will gain market share and it will be reflected in the value of their stocks and bonds . . . one has to fully understand an entity’s ability to generate cash flow to meet their debt service and to grow their enterprise.

While rates on CDs and other short term deposits have come down, I still believe it is prudent to remain defensively positioned at this juncture. As the liquidity needs increase – and they are – opportunities will develop in a wide array of markets. While it may be prudent to buy short term bonds of highly rated companies, I still think people should keep plenty of dry powder. Within equities, companies with pricing power (ability to increase prices in an inflationary environment) will outperform.

4. Other Highlights . . .

If the government accedes to the pressure being applied to suspend the mark to market accounting principle, I would expect that move would only prolong the underperformance of the economy . . . I view a suspension of the mark to market as the equivalent of an agreement to officially allow one to “cook their books.”

I very much believe this and maintain this viewpoint.

SELL RALLIES . . . while financial institutions have been feeling the pain of overleverage for the last 12 to 18 months, that pain is just now coming to bear on the consumer . . . given that the consumer represents app 70% of our GDP, the expected precipitous drop in consumption across a wide array of products and industries will be very painful . . . you will see a litany of corporations announcing layoffs on a regular basis . . . Pepsi did just that this morning.

I also maintain this premise. I believe we will experience double digit unemployment this year given the problems in the automotive (production, parts, and dealers), and municipal sectors (forced cuts as tax revenues plummet. California is the poster child!!). Retail sales will remain low keeping domestic production and imports also depressed.

Please share your thoughts and opinions. Each and everyday is a microcosm, but we need to maintain the macro view as we navigate the economic landscape!!

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