Sense on Cents

A New Bull or a Bear Market Rally?

Posted by Larry Doyle on May 17th, 2009 9:02 AM |

Are we entering the initial stages of a bull market or experiencing a bear market rally? Does our economy have the requisite liquidity to finance the deficit or is the liquidity trapped by embedded losses in the banking sector? Will tax revenues be sufficient to address municipal obligations? Ultimately, what does it all mean for our economy and the global economy.

Our Economic All-Star John Mauldin and his colleague Niels Jensen of Absolute Return address these critical questions in an easy to understand fashion in The $33,000,000,000,000 Question.

As we enter the ‘Brave New World’ economy, I believe it is critically important we revise our mental approach to the economy and markets. I share the concerns voiced in this piece. If nothing else, Jensen’s detailed analysis provides insights into the hurdles we face as we try to move forward. I hope it helps you navigate your personal economic landscape.

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Speaking to New York State Society of CPAs

Posted by Larry Doyle on May 16th, 2009 6:06 PM |

I will be addressing the New York State Society of CPAs Chief Financial Officers Committee this Tuesday. I will be giving my views on the economy, the markets, global finance, and asset allocation.

I welcome the opportunity to share my views at this conference. Additionally, I am happy to engage others who may want me to speak in small or large settings, either in person or via conference call.

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Tune In Sunday Night for NoQuarter Radio’s Sense on Cents with Larry Doyle

Posted by Larry Doyle on May 16th, 2009 11:35 AM |

UPDATE: The show has concluded, but you can listen to a recording of it in its entirety by clicking the Play button on the audio player below. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar.

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Please join me Sunday evening from 8-9 p.m. ET for NoQuarter Radio’s Sense on Cents with Larry Doyle. The developments in the markets, economy, global finance, Wall Street, and Washington are occurring at breakneck speed. I will try to slow things down a bit and provide a sense of perspective. What did we learn in the markets over the last week and what does that mean for the weeks and months ahead? We will address a wide range of issues, including economic statistics released this week, the automotive situation, market performance, and the road ahead. Additionally, I am always happy to address anything on your mind as you navigate your own economic landscape.

I will be joined by a special guest this week, as well. Mike Offit is uniquely positioned to offer piercing insights on the current state of Wall Street, the markets, and the economy. Mike held senior positions at First Boston and Goldman Sachs prior to launching the commercial mortgage and asset-backed securities business unit at Deutsche Bank. He currently consults and writes extensively on a wide range of issues for a number of periodicals including a lifestyles column for Departures, the AMEX Platinum/Black card magazine. Mike has unabashedly always “tilted against windmills.” I look forward to my conversation with him this Sunday evening.

These are truly historic times in the global economy. Let’s “navigate the economic landscape” without the pandering or nonsense found elsewhere! What is on your mind? What would you like to address? Please share your questions and thoughts by calling in to (347) 677-0792, and also join our live chat room, which I’ll start up about 10 minutes before the show begins.

Many thanks to Larry Johnson and the rest of the team at NoQuarterUSA blog for providing such a vibrant vehicle as NoQuarter Radio. I look forward to having you join me Sunday evening as we collectively navigate the economic landscape!!

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Arne Duncan Visits Detroit; He Should Visit Domus

Posted by Larry Doyle on May 16th, 2009 9:04 AM |

Our nation faces many huge problems but none greater than the issues in urban education. President Obama has experience in this area during his time in Chicago. Not surprisingly, he went to his roots and brought Arne Duncan from Chicago to Washington to head the Department of Education. Let’s check in with Mr. Duncan.

Duncan recently paid a visit to Detroit, home to the worst public schools in the country (based upon graduation rate). The Washington Post offers insights on his visit, Duncan Delves Behind Grim Statistics.

While this article asserts the graduation rate for 9th graders in Detroit is 38%, it fails to address that there are plenty of students who drop out prior to 9th grade. The actual graduation rate in Detroit is an abysmal 25%!! The overall graduation rate in urban schools is a paltry 50%.

Duncan has been given a massive checkbook to address education issues in our country. Rest assured, money is part of the problem. However, in my opinion, money is not the critical issue. As the Washington Post’s article highlights, many students in urban settings are involved in gang activities. Regrettably, gangs have replaced traditional families. Why? Well, I am not a sociologist nor a psychologist but I have to believe when so many newborns enter this world into single parent families (70% of newborn African Americans enter this world into a single parent family, 50% for Hispanics, 30% for Caucasians), they have one strike if not two against them before the game has even begun. These kids will look for structure somewhere. Regrettably, the gang becomes the structure.

I addressed this sensitive, but critically important, topic last Fall. Please allow me to go to the archives and revisit, “Give a Man a Fish, Feed Him For a Day…”

My point in writing that article was to highlight the cold but sobering reality of graduation rates in urban settings and the correlation with incomes. I also wanted to address the hurdles presented by the bureaucracy embedded in teacher unions.

My article back then elicited much feedback from readers, business associates, friends, and family. Often, the question was raised as to what could be done to address the core problem – the lack of family structure in urban settings.

As fate would have it, I had the good fortune of meeting an individual this week who for the last 26 years has been doing miraculous work in this area. Mike Duggan, who graduated a year ahead of me at Holy Cross, started his career in the Bedford-Stuyvesant section of Brooklyn, New York. In the early 1990s, Mike was recruited to Stamford, CT to overtake a program called Domus, which “helps over 600 children and their families experience academic and life success through educational, residential, and community programs.” At the time Mike joined Domus, it was $300k in debt and hanging on by a thread.

Domus is now a thriving organization with an $11 million annual operating budget. Duggan has worked magic in the face of extreme challenges. The Domus program is all encompassing. Ultimately, the foundation is based on “tough love” with the emphasis much more on the love than the tough. In my meeting with Mike, he offered that he does not allow his students to view themselves as victims. The mayor of Stamford has publicly praised Mike and Domus for the profound impact they are having on the Stamford community.

I asked Mike if there are other programs similar to Domus in the country. He offered that there are two. As I recall, one is in Texas and one in California.

Plenty of naysayers may believe our urban education problem can’t be solved. Plenty of educational bureaucrats may say urban schools simply need more money. I say there is a third path. Our country needs to promote Mike Duggan and his work at Domus on a grand scale.

Mr. Duncan, please visit Stamford, CT and replicate the Domus model nationwide.

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Social Security, Medicare, Increasing Deficits: How Will We Manage?

Posted by Larry Doyle on May 15th, 2009 4:29 PM |

The immediate issues of rising unemployment, increased foreclosures, available credit and the like dominate our economic landscape. That said, the mountainous hurdles on our economic landscape – Social Security, Medicare, and the Federal deficit – are getting larger and more in focus.

This week we have witnessed the following news releases:

Financial Health of Social Security, Medicare Worsens In Past Year as reported by Fox News.

Given plunging tax revenues due to increased unemployment, Medicare is actually running a net deficit this year. It will become insolvent at this rate in 2017, two years earlier than previously projected.

Given revised projections, Social Security will start running an annual deficit in 2016, a year earlier than previously projected. The fund will become insolvent in 2037, four years earlier than projected.

Does the American populace believe somehow or other a Wizard in Washington will solve the financial sinkhole represented by these two programs?

Are revenues going to miraculously appear to plug the holes in these funds? Don’t count on it. Without an increase in revenues, the government will obviously have to deal with the liability side of the equation. This liability side is only exacerbated by the soaring deficits. It was interesting to hear President Obama acknowledge the price of soaring deficits, that being higher interest rates, this week. As Bloomberg reported, Obama Says U.S. Long-Term Debt Load ‘Unsustainable.’

While Uncle Sam may spend millions of dollars and thousands of man-hours reviewing these programs and expected future costs, as with any debt, there remain three options: default, devalue, restructure.

I do not believe Obama or anybody else believes default is an option. Devaluing the debt is clearly on the front burner of the Fed, Treasury, and throughout Washington. How so? Keep the Fed Funds rate at 0-.25% until we get inflation going. If the “Washington wizards” believe they can control the inflation monster, that will be a miracle.

In regard to restructuring the debt embedded in these programs, I have no doubt we will see this happen on a grand scale. How so and when? In my opinion, given the magnitude of Obama’s plans across healthcare, energy, education, and the economy, he needs to find real savings somewhere.

In my opinion, I expect the future obligations of Social Security and Medicare to be written down during Obama’s first term by excluding payments to individuals whose net worth exceeds a certain limit. What number may that be? I would have to review analysis of demographics and net worth statistics to venture a guess.

This restructuring would be the greatest redistribution of wealth our country has ever seen. Similarly, it would define these programs as nothing more than government sponsored Ponzi schemes.

I see it happening. What do you think?

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What is Going on with LIBOR?

Posted by Larry Doyle on May 15th, 2009 12:47 PM |

Libor (London Interbank Overnight Rate), the cost of borrowing U.S. dollars in the overnight market, is plummeting. What is driving this move and what does it mean? A number of people in global finance are asking that very question. Let me offer my opinion.

After Lehman failed in September 2008, confidence in banks declined precipitously, counterparty risk soared, and Libor screamed higher as well. 3 month Libor topped out at close to 5%. Historically, Libor is just marginally higher than the Fed Funds rate which is currently between 0-.25%.

Today 3 month Libor is approximately .8%. This move lower is a clear sign of increased confidence in the banking system, isn’t it? In my opinion, this move in rates is a reflection of the following:

1. a realization that global governments will not allow major money center banks to fail.

2. a reflection of the massive increase in dollars in the system associated with all of the liquidity injected via Uncle Sam’s programs.

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.

Maybe a drop in Libor isn’t such a great development after all.

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Heavy Losses Raining on Insurance, Roll Out The TARP

Posted by Larry Doyle on May 15th, 2009 8:29 AM |

The fact that a handful of insurance companies are eligible to receive government funding via the TARP is a much bigger event than the benign media reports would indicate. In my opinion, the news reported by Bloomberg, Prudential Said To Be Among Insurers Cleared For TARP, is a clear sign of a much larger storm on the horizon. Why? Let’s get after it.

Not every insurance company has the same business profile. Some are more aggressive in underwriting. Some are more aggressive in their investment portfolio. Some are more aggressive in their product offerings. That said, they’re all members of the same family and if one has the flu, you can rest assured many others are also sick.

On March 12th, in Is My Insurance Insured?, I wrote:

While the government has already taken an 80% stake in AIG, how do the state insurance commissioners deal with entities like Hartford, Met Life, and others with outsized risks and resulting declining capital cushions? Let’s go visit Uncle Sam!! That’s right, if you thought “bailout nation” was already swamped by banks, automotive companies, and Freddie/Fannie, the fun continues: The Next Big Bailout Decision: Insurers.

Fast forward to May 15th and here we are.

Why do the state insurance commissioners have to go to Washington? What about the reserves at the state level? Well, are you sitting down? Those reserves nationwide total only $8 billion.

Can insurers write enough premiums quickly enough to generate sufficient capital to address the losses? That is the $64 billion question. Actually, it will likely be much larger than that. Why?

As consumers are strapped for liquidity and getting credit lines squeezed – if not totally cut by their banks – they will look to tap the cash value of their insurance at an ever greater rate. If consumers were to triple the rate at which they have tapped these lines, the insurance industry would experience a capital drain of approximately $500 billion. Insurance companies will be forced to raise capital via debt or equity offerings, asset sales, or drawdowns of cash and liquidity reserves. The industry has approximately $450-$500 billion in cash and liquidity reserves. “Houston, we’ve got a problem.”

Haven’t insurance companies benefitted from the relaxation of the mark-to-market? No, they do not utilize that form of accounting. Insurance companies typically carry assets at cost or model valuations. If and when the assets suffer a prescribed level of defaults, the losses must then be recognized via a write down in the asset’s value. As losses via defaults and foreclosures across their assets continue to increase, well, that’s why we just saw these insurers “roll out the TARP.”

Can’t the insurance companies sell their assets to stem the losses? Not easily. Why? Insurance companies have traditionally reached for yield (higher rates of return) by purchasing higher risk assets or writing higher risk insurance. In doing so, the industry has sacrificed the liquidity associated with lower risk assets/products. What are these assets and where do the problems lie?

1. Annuities: this product was aggressively underwritten by insurance companies after the meltdown of the NASDAQ in 2001-2002. A principal protection component was particularly attractive to many investors. That component provided investors downside protection but is now a large source of pain for the industry. In short, investors won, insurance companies lost as the market plummeted.

2. Commercial Real Estate: aside from the banks, insurance companies are the largest underwriters and holders of CRE. Insurance companies not only originated billions in CRE but they were typically the biggest buyers of the subordinate classes of CMBS (commercial mortgage backed securities) deals underwritten by Wall Street banks.

3. Defaults: with default rates on loans (mortgages, corporate, commercial real estate) expected to at least double, likely triple, and in the most credit sensitive sectors potentially quintuple, these losses will quickly burn through established reserves.

As Bloomberg reports:

“If you had some of these companies, the bigger ones like Hartford, go into a spiral, that would just cause another round of panic,” said Robert Haines, a New York-based analyst at CreditSights Inc. “I don’t like the idea of the government getting involved with these companies. You’re making to an extent a deal with the devil, but your options are really limited at this point.”

The problems within the insurance industry are not contained to the firms (Hartford Financial, Prudential, Principal, Allstate, Ameriprise, and Lincoln) that received approval for TARP funds. These institutions are eligible for government funds via TARP because they have bank subsidiaries or have purchased a bank or S&L. What about the insurance companies not in that position? Stay tuned.

Sense on Cents will be monitoring this situation very closely.

For a compilation of posts by Sense on Cents on this topic:

January 12th: Got Insurance? 529 Plans? Financial Aid? Read On…
-an interview with Sean D’Arcy, a longstanding professional within the insurance industry and financial planning space. Sean laid out all the problems.

March 12th: Is My Insurance Insured?
-a review of the fact that policyholders have credit exposure to their insurance carriers.

March 30th: What Is Lincoln Thinkin’?
-a review of Lincoln Financial’s purchase of a small savings and loan in Indiana in order to gain access to government funding.

April 6th: Insurance Companies’ Ignorance Is Definitely Not Bliss!!
-a survey of insurance brokers in which the brokers maintain the insurance companies did not appreciate and understand the degrees of risk embedded in insurance products sold.

April 7th: Uncle Sam To Throw Lifeline To Life Insurers
-a post pointing toward the move made yesterday.

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Barney Frank: Twenty Years and Hundreds of Billions Later on Private Profit/Social Loss

Posted by Larry Doyle on May 14th, 2009 3:18 PM |

I find it embarrassing that our country is subjected to the leadership of the likes of Barney Frank. In a 7 minute interview on Bloomberg News this morning, I was initially shocked at Congressman Frank’s selective memory. As I watched the interview further, I got increasingly perturbed and upset that our country is subjected to a Congressional leader with such little appreciation for his own mistakes. From there, thinking that Barney and his colleagues are likely to impose their will and vision upon our economy makes me more concerned about the long term risks for our market and capitalism itself.

I am not blinded by the will of the free market. For a market to remain free, there needs to be strong regulation and real discipline. If the market does not impose the discipline, the government can and should provide guidance, incentives, and if need be hard rules. For the regulation to be effective, though, it is imperative that the regulators themselves are unbiased and unaffiliated within the industry. I would say that both FINRA and the SEC have fallen woefully short on these fronts. I would also say that Congress has fallen woefully short. Against that backdrop, to see none other than Barney Frank trying to make the case for the way forward on compensation reform and municipal insurance is VERY HARD TO SWALLOW.

In regard to compensation reform, I am all for empowering shareholders. I would begin by asking, though, when did shareholders lose the ability to influence compensation? Shareholders should regularly review compensation practices and figures and if they find them problematic, they should voice their opinions and if need be sell their stock.

As Barney was raising the risks embedded in the private profit and social loss model, I wanted to scream and ask him where he was as Franklin Raines was plundering Fannie Mae with Barney’s support on the Hill. Finding religion on these topics after twenty years and hundreds of billions of dollars may appease his constituents, but it does nothing for those who cherish free market capitalism.

Make no mistake, government was a large part of the problem then which makes me leery to think that it can be an effective part of the solution now.

To also hear Barney offer his opinion on the relative value of municipal debt versus corporate debt made me want to change the channel. The link to Barney’s Bloomberg interview is provided below. Let me know if you were able to stomach it before changing the channel.

Barney Frank, September 25, 2003 on the topic of sub-prime lending:

“I want to roll the dice…”

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Economic Update: Jobless Claims and Producer Prices

Posted by Larry Doyle on May 14th, 2009 10:42 AM |

Economic data released this morning included Initial Jobless Claims and Producer Price Index. Let’s dive right in!!

Initial Jobless Claims rose to 637k from last week’s reading of 601k, which was revised to 605k. The expectations for this week’s claims figure was 611k so the reading is disappointing as far as looking for stabilization within labor.

I am not surprised, though, for a few reasons:

1. we know there are going to be layoffs coming in the automotive industry. In fact, a large percentage of the increased unemployment filings came from states with heavy automotive exposure, especially Illinois.

2. as I reported in last Friday’s May Unemployment Report:

The fact that temporary government workers are factored into overall employment, in my opinion, is stretching the integrity of the report.

Thus, I am not surprised to see this week’s claims report higher than expected and I expect subsequent revisions to show higher claims as well.

In regard to the Producer Price Index, it was reported as an increase of .3% and without the volatile food and energy components as an increase of a mere .1%. No big deal, right? Well, it’s no big deal as long as you don’t eat. For those of us who actually look to consume food on a regular basis, this report is very troubling. Why?

Prices of food products rose 1.5%!! Including a rise of 43.7% for eggs, 5.2% for vegetables, 4.5% for beef, and 2.5% for pork.

Sense on Cents did receive very interesting color the other day about the state of produce in California. A reader shared:

The cost of food is on the rise faster than you can eat.
Now the feds have cut off water to the central valley and fields are not being farmed. I do not about you but ya might want to watch the price of a head of lettuce in NYC go through the roof.

Additionally, I was surprised to see a rise in prices for cars of .2% and light trucks of 1.1%. Despite the fact that car and truck sales are at depressed levels, the auto companies are in such desperate straits that they need to squeeze revenue wherever possible. That said, the asking prices of these vehicles may have risen, but who pays asking?

Please share insights on these fronts or any others from your local economies so we all can more effectively navigate the economic landscape!!

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California’s Budget Crisis: Welcome To The Hotel California

Posted by Larry Doyle on May 14th, 2009 8:16 AM |

Welcome to the Hotel California
Such a lovely place
Such a lovely face
They’re living it up at the Hotel California
What a nice surprise
Bring your alibis

Is California preparing to invite Uncle Sam to this party to clean up the Sunshine State’s fiscal mess or at the very least provide a “letter of credit?” I wrote the other day, As California’s Economy Goes, So Goes The Country. Well, now Bloomberg reports, California Seeks U.S. Help With Record Borrowing For Budget Gap. How would Uncle Sam’s largesse be dispensed? Bloomberg offers:

California asked the U.S. Treasury for help with sales of short-term notes as the recession threatens to force the most-populous state to borrow as much as $23 billion to pay its bills.

The federal government should use the Troubled Asset Relief Program to buy the notes of any state that defaults, California Treasurer Bill Lockyer said in a letter to Treasury Secretary Timothy Geithner yesterday that was released by his office. A guarantee would make it easier for states to purchase the bond insurance policies they need to attract investors.

“If we cannot obtain our usual short-term cash flow borrowings there could be devastating impacts on the ability of the state or other governments to provide essential services to their citizens,” Lockyer said. “Such a scenario could also cause major disruption to financial markets.”

At what point do the occupants of the Hotel California come to realize that the “fiscal follies” come with a price? The beast in the form of runaway spending and ill-conceived programs now controls the state. Who within the hotel is willing to accept responsibility for this fiasco? Which representatives of the Hotel California in Washington (Pelosi, Feinstein, Boxer) will accept the reality of:

Mirrors on the ceiling, the pink champagne on ice
We’re all just prisoners here of our own device

Yes, California’s fiscal disaster is of its own device. Other states have not forced it to live beyond its means. If Uncle Sam does provide this backstop via the TARP, is the benevolent old man effectively enabling these wayward children to live in a profligate fashion? Can’t the residents of the Hotel California tame their fiscal monster amidst real debate, sacrifice, and prudent planning?

In the master’s chambers, they gathered for the feast
They stab it with their steely knives, but they just can’t kill the beast.

Well, no surprise that the residents of the hotel will now impose upon a member of Uncle Sam’s contingent unfamiliar with the concept of fiscal discipline. As Bloomberg offers, in regard to the Treasurer of the Hotel California:

Lockyer has also spoken with U.S. House Financial Services Committee Chairman Barney Frank, who is working to get federal support for municipal debt. Lockyer, in his letter, said that debt guarantees through the TARP program would allow the state to get the credit lines it needs.

Meanwhile back at the hotel, many residents are actually looking to move out if and when they can. The prospect of moving from the Hotel California is not easy but there has been significant demographic transition from Hotel California to surrounding states for over the past decade. I would look for this to continue.