Sense on Cents

Economic Data and News Below The Radar

Posted by Larry Doyle on May 13th, 2009 8:27 PM |

While navigating the economic landscape, I picked up a few items below the radar:

1. projected issuance of U.S. Treasury bills, notes, and bonds for calendar 2009 will be $2 trillion. To put that in perspective, that figure exceeds the issuance for 2006, 2007, and 2008…..COMBINED.

2. seven senior executives at GM sold all of their stock in the company. With the price of GM in the $1.25-$1.50 range, this sale is a clear indication that the company will either file for bankruptcy or massively dilute existing shareholders in a restructuring.

3. 1st quarter tax revenues in 47 states declined on average by 12.6% year over year with expectations of steeper declines going forward. Increased taxes and declining services are on their way. I also mentioned to my better half, I expect states to pass legislation promoting “sins” in an attempt to generate revenue.

4. our economy is experiencing the highest inflation adjusted level of interest rates since the ’80s. These rates along with anemic consumer demand are squeezing company bottom lines. As a result, companies are aggressively cutting expenses while revenue opportunities are diminishing.

5. the IMF has indicated that European banks should undergo stress tests much like our domestic banks.

6. the GAO (General Accounting Office) issued a scathing report highlighting how deficient the SEC is in terms of equipment, systems, staffing, and execution. No surprise, but very disheartening.

7. I have added a link which I think readers will find quite informative. Subsidyscope, launched by the Pew Charitable Trust, will track federal subsidies across industries. In the Uncle Sam economy, this link should prove to be invaluable.

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If Shipping Is Up, What About Rail Activity?

Posted by Larry Doyle on May 13th, 2009 3:26 PM |

I just reported in my prior post that the Baltic Dry Index (measuring global shipping activity) is rising and has risen close to 45% over the course of the last month. This is clearly a sign of increased economic activity and a turn in both our domestic and global economy, correct? Clearly the rise in the BDI must be correlated with a rise in rail activity here in the United States as we get our goods and commodities to port. Let’s jump on the rails and go for a ride navigating this part of our economic landscape.

Uh-oh!! It is not widely broadcast but rail activity is not only down year over year (no surprise there) but the pace of decline is quickening. The theory behind the green shoots is promoted by analysts as a slowing in the pace of economic decline. How did they miss this data? Are they not looking or not reporting?

Let’s review. The Heard on the Street column in the WSJ reports, Risk In Market’s One Track Mind.

In reviewing this piece, I was particularly struck that the pace of decline in rail activity from the 1st quarter 2009 to this point in the 2nd quarter is QUICKENING.

As the WSJ highlights:

The slump in weekly rail traffic reflects sluggish industrial activity and consumption. Shipments of industrial products are down almost a third in the past year, while raw materials like coal, metals and crops also show steep drops. The pace of decline has picked up relative to the first quarter’s 16% fall, according to Credit Suisse analyst Chris Ceraso.

In commodities, while crude oil and copper have been on a tear, prices for lumber and natural gas remain depressed. Lumber is exposed to construction and has been in a bear market since 2004, so it might be regarded as a special case. Still, there is little sign of a rebound.

The fact that rail traffic is declining at a quickening pace is inconsistent with other analysts promoting that our economy is turning. This same trend is occurring in trucking as well.

That light in the economic tunnel? It may not be daylight. Based on this report, it may not be a train either. Perhaps it is merely a reflection of overly optimistic analysts and pundits who are trying to sell you something. Ask them what they think about rail traffic.

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Let’s Get Some Chinese: A Review of Economic Activity in China

Posted by Larry Doyle on May 13th, 2009 11:59 AM |

China’s stock market closed today at the highest level since August ’08. Is that an indication that China is ready to resume its economic expansion and can literally pull the global economy right along with it? Well, let’s check out a number of items on the menu:

1. The Baltic Dry Index has rebounded over the last few weeks. The BDI is extremely volatile. It plummeted approximately 95% from its high in early 2008, rebounded strongly earlier this year only to suffer a setback in March as our equity market started to regain its legs. The recent rebound in the BDI is again credited to increased shipping activity of commodities into China. Prices of commodities (copper, oil, iron ore) have been very highly correlated with the BDI as a result.

So far, so good . . . let’s try some more items on the menu.

2. How about Chinese lending activity? Is the well directed Chinese stimulus precipitating an increase in activity by non-governmental borrowers? The FT reports, China Cuts Lending Amid Asset Bubble Fears.

I will give those in charge of China’s fiscal stimulus and government programs credit. As this article highlights, these authorities have real concerns about inflation and irresponsible lending practices.

The FT reports:

Chinese bank lending slowed dramatically in April because of fears that loan growth in the first quarter had been excessive and could pave the way for loans of deteriorating quality, so possibly creating a new round of asset bubbles.

That led to fears among regulators that money was being funnelled illegally into the stock market and handed out to state-sponsored stimulus projects of dubious commercial value that could become non-performing assets.

Some regulators also worried about the potential for rampant inflation. Those fears were somewhat eased by price measurements released on Monday showing China remained in deflationary territory in April for the third consecutive month.

Wow! Can you imagine if a regulator in our country had the integrity to voice concerns about government funds being utilized illegally or fraudulently?

This item did not taste so good in regard to leading the global economy to greener pastures, but I commend the Chinese for addressing potential pitfalls in their programs.

3. Away from the government stimulus, the Chinese economy remains largely dependent on exports. Let’s take a taste! Again, our friends at the FT provide some spice, Slide In Chinese Exports Will Hit Growth Strategy:

The FT reports,

Chinese exports fell steeply in April for a sixth month in succession, suggesting that the worst might not be over for the world’s third largest economy.

The total value of Chinese exports fell 22.6 per cent to $91.9bn (£60.2bn) last month compared with the same month a year earlier – a faster rate of decline than the 17.1 per cent year-on-year drop in March.

Why are Chinese exports falling? Well, please review our first post this morning which highlighted that domestic retail sales here fell by .4% after a decline of over 1% last month. If American consumers aren’t buying, Chinese producers aren’t exporting.

4. LD, it is only a matter of time, though, before the American consumer returns to his old ways of spending and the Chinese exporters will be happy, right? Let’s go for the fortune cookie and see what it says: U.S. Lawmakers In Threat To Raise Tariffs On China.

Congress is raising this threat given rising unemployment here at home and concerns that China manipulates its currency. Will this tariff fly? Perhaps.

The FT reports:

a group of lawmakers from manufacturing-dominated states are determined to give it another try and some analysts think the US recession could help build support this time. The charge in the Senate will be led by Debbie Stabenow, a Democrat from Michigan, and Jim Bunning, a Republican from Kentucky. In the House, it will be pushed by Tim Ryan, a Democrat from Ohio, and Tim Murphy, a Republican from Pennsylvania.

Whether these tariffs are the right maneuver or not, increased protectionsist measures are not one way streets. If we are looking to grow our own economy without being dependent on the American consumer, we will need global trade lines to be open.

So, what did you think of our sampler?

To me it was more sour than sweet. In my opinion, our future/fortune remains decidedly mixed at best.

For more in depth BDI analysis, check out Baltic Dry Index and Commodity Graphs

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Economic Update: Housing and Retail Sales

Posted by Larry Doyle on May 13th, 2009 8:39 AM |

Ultimately, all economic roads lead back to the housing market. The breakdown in the integrity of housing finance led us into this economic mess and any self-respecting economist (or financial commentator) will tell you that a healthy housing market will lead us out. Let’s check the patient.

The Fed has supported housing by effectively “overpaying” for refinancings. Mortgage rates relative to rates on U.S. government debt are at 17 year narrows. This development is great for homeowners who can and have refinanced. However, the pool of eligible homeowners is finite and seems to have run its course for now as recent data indicates that refinancing filings have declined while purchase activity has been unchanged. This data is reflected in the U.S. MBA Mortgage Applications Index Fell 8.6% Last Week, as reported by Bloomberg.

How about new supply of homes coming onto the market? Well, certainly home building has come to a virtual standstill with over a year’s worth of homes currently on the market. As new housing starts occur this supply can be gradually absorbed. Thus, we once again are back to the concept of needing time for the patient to heal. However, are we subject to another bout of housing sickness to hit our economy? I believe we are. Why? Two reasons:

1. government programs forestalled but did not eliminate a number of “sick” mortgages. These mortgages would likely have defaulted with banks forcing foreclosures a few months ago.

2. a large supply of adjustable rate mortgages will soon reset to a considerably higher rate leading to payment problems for homeowners and likely foreclsoures. Data indicating increased rates of delinquency (late payments) clearly points to increased foreclosures.

In fact, foreclosure filings just hit a record level of 342k as reported by RealtyTrac which monitors this data nationwide. Foreclosure activity also seems to be spreading from California, Florida, Nevada, and Arizona to other parts of the country. In fact, Idaho has recently had a surge in foreclosure activity as the unemployment rate in and around Boise has spiked.

What about home prices? The declines in home prices have certainly sparked renewed interest in prospective homebuyers. Will they enter the market at this stage? Data indicates prospective buyers continue to be patient as Bloomberg reports, Home Prices In U.S. Drop Most On Record In Quarter.

When may consumers feel confident enough to enter into the market and purchase a home? The largest factor in that decision is consumer’s confidence in their employment situation. In my opinion, with the rate of unemployment nationwide likely to hit double digits by year end, housing will remain under pressure.

On a separate economic note, the retail sales figures for April were just released and declined .4%, and excluding auto sales, declined by .5%. The market expected April retail sales to be unchanged. This report is a clear indication the economy remains on life support. Not surprising to me, March retail sales were revised even lower from a decline of 1.1% to a decline of 1.3%.

With all due respect to credible journalists, analysts, and financial commentators, I personally do not see enough green shoots in the midst of reviewing the entire economic landscape.

The equity markets are moving sharply lower on this news.

P.S. Sense on Cents welcomes feedback. Let us know what you are seeing in your local economies.

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As California’s Economy Goes, So Goes the Country

Posted by Larry Doyle on May 12th, 2009 5:15 PM |

Political hacks assert, “all politics is local.” In a similar vein, armchair economists propose, “as California goes, so goes the country.” Why is that? California represents such an enormous part of our country in many respects, including the following:

– 8 of the 50 largest cities

– population of approximately 37 million people (that we know of), a full 12% of our national population

– an economy similar in size to Italy, ranking it as one of the top 10 in the world (I have seen rankings of 8th and 9th)

– California’s economic output represents 13% of our national GDP!!

– an unemployment rate north of 11% compared to the national average of 8.9%. With a high unemployment rate amongst illegal immigrants, it is not a stretch that California’s unemployment rate is approaching 15% and its underemployment rate is greater than 20%!!

The results of the Bank Stress Tests indicated that Bank of America and Wells Fargo had the greatest capital shortfalls. Why is that? BofA already had a huge market share in California and it grew exponentially with its purchase of Countrywide. Wells Fargo also had huge market share in California and it only grew with its purchase of Wachovia. Hey LD, Wachovia is a North Carolina based bank, how could that correlate into increased California exposure? Wachovia purchased Golden West Financial, a southern California based bank which had been one of the most aggressive lenders of a mortgage product known as pay-option ARMs. Suffice it to say that product has been a disaster in terms of delinquencies, defaults, and foreclosures.

Earlier this year, California faced a massive budget shortfall and experienced significant political turmoil in passing a budget. Well, the Governator Arnold Schwarzenegger is right back in the ring as California’s fiscal situation is faced with more sinkholes. The WSJ reports, Cuts Loom in California if Propositions Fail.

While politics may be local, the economic fallout from California can not be walled off from the rest of the country. The capital cushions that BofA, Wells Fargo, and many other banks are forced to set aside against consumer, corporate, and municipal defaults literally ripple across our entire country. The WSJ reports:

California’s fiscal plight is worsening. In a letter sent Monday to the state’s legislative leaders, the governor said the Golden State now projects a new $15 billion shortfall, up from a previous estimate of $8 billion, because of plummeting tax revenue amid the recession. That figure would jump to $21 billion if Californians next week defeat the propositions, Mr. Schwarzenegger said.

Professors Ken Rogoff and Carmen Reinhart, in a dissertation, “Aftermath of Financial Crises,” highlighted declining tax revenues as one of the driving forces to increased fiscal deficits, greater government borrowing, further crowding out, and an underperforming economy. While the Governator is locked in a battle with the legislature, municipal unions, and other constituencies over the state’s fiscal follies, is California an opening act to the same show in Washington over the next few years?

Would our friends from California please share some perspectives? I thank you.

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Save GM? OK . . . Save GMAC? What’s Up With That?

Posted by Larry Doyle on May 12th, 2009 1:57 PM |

Does Uncle Sam really need to take a greater equity stake in auto and housing finance? Doesn’t our exposure to Freddie and Fannie along with our soon to be equity stakes in Chrysler and GM provide us enough exposure? Why does Uncle Sam need to own a non-systemic risk housing and auto finance company?

Our economy has been faced with massive systemic risks within certain companies – Fannie Mae, Freddie Mac, AIG, and Citigroup. Similarly, the Obama administration views our domestic automotive industry as critical to a healthy, vibrant, growing industrial base within the United States. While the futures of these aformentioned industries and companies can be hotly debated, an entity such as GMAC (General Motors Acceptance Corporation) does not present systemic risk.

Who wins with Uncle Sam taking ownership of GMAC? Obviously the employees of GMAC, entities that have outstanding exposure to the company, and consumers who will receive below market financing. Who loses? The competition. Regrettably, the tried and true principle of healthy competition has taken a back seat in our Uncle Sam economy.

Ford Motor won the battle of the Big 3. In this case, though, to the victors do not go the spoils. Ford Motor Company deserves huge praise. Ford recognized the changing business model of the domestic automotive industry in advance, addressed its finances and adapted its business model. Today they are expected to issue 3 million new shares of stock. I hope the sale exceeds expectations and they gain huge market share.

The WSJ highlights the fact that in the brave new world of the Uncle Sam economy, Uncle Sam’s money management enterprise will have major equity stakes in Freddie Mac, Fannie Mae, AIG, Citigroup, and soon GMAC. Get Ready:You Will Own GMAC, Too.

GMAC differs from other companies under the government thumb because it isn’t too big to fail. So the government doesn’t need to save GMAC to safeguard the financial system.

Instead, GMAC must be saved, the argument goes, to revive the auto industry and consumer economy. The details of that approach are strikingly scarce. In fact, nearly everything about GMAC — its mission, board, and future ties to government — is unknown. As Winston Churchill might put it, GMAC is a financial black hole stuffed into a governance black box.

These details matter. The Treasury is in the middle of a plan to turn privately held GMAC into a new über auto-lender, financed with taxpayer dollars and likely falling under taxpayer control. This has the potential to spark unintended consequences across the auto and banking markets, similar to the quasigovernmental meddlings of Fannie and Freddie.

Would this government-sanctioned company have an unfair funding advantage against Ford Motor’s Ford Motor Credit, for instance? Would it be willing to do the politically unpalatable work of cutting credit to certain car dealers? What happens if Congress starts mandating low-cost auto loans?

How many diligent, determined, and patriotic individuals are there in our country today questioning how and why their work ethic and competitiveness have been devalued by Uncle Sam’s entrance into an entity such as GMAC? It is naive to think that the playing field can remain anything close to level in auto and housing finance going forward. How does one compete with Uncle Sam’s ability to finance itself? Where’s Congress on this topic?

Oddly, Congress and the rest of the country seem to have grown numb to the bailouts. Not once has GMAC been discussed substantively in a congressional hearing.

The next time President Obama opines that he wants to promote private enterprise and that he does not want to be in the housing and auto finance businesses, let’s ask him about G-M-A-C!!

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Does HSBC See Green Shoots?

Posted by Larry Doyle on May 12th, 2009 11:41 AM |

Are those green shoots or dandelions or a mix of the two?

As the “lawn” comes in, we hope the roots grow deep and the grass is lush. That said, we can not blindly accept a prospective landscaper’s vision of what our yard may look like next quarter or later this year. I don’t subscribe to using products like Miracle-Gro. Given that virtually every “gardener” is employed or connected to “Uncle Sam’s Lawn Patrol,” who else can give us a “lay of the land”? Let’s talk to the gardeners at HSBC!

HSBC purchased Household Finance in 2003. I am sure they regret making that purchase. HSBC was trying to emulate the “originate to distribute” model which filled the coffers of so many other Wall Street banks. The fact is, though, HSBC was literally the last entrant to the “lawn” party and their experience has been nothing short of a whole lot of crabgrass.

As the WSJ reports, HSBC Points To More Pain In U.S., we receive a diagnosis on the U.S. economy that is much less sanguine but, in my opinion, more realistic than Uncle Sam’s gardening crew. The WSJ highlights the fact:

HSBC, which was among the first banks to signal the subprime-mortgage troubles that set off the global financial crisis, said its U.S. consumer-finance operation had seen a slight slowdown in the deterioration of its mortgage and other secured loans in the first quarter compared with the fourth of quarter of 2008 — a shift executives attributed in part to U.S. tax refunds, higher savings rates and the bank’s efforts to help borrowers by changing the terms of their loans.

While those signs of a slowdown in loan deterioration may be viewed as a “green shoot,” HSBC is an honest “gardener” and allows that the positive trend may not continue.

North America Chief Executive Brendan McDonagh attributed the change to several factors, including a seasonal bounce, tax refunds, loan modifications and the bank’s previous efforts to pull back in mortgage lending. “We are slightly encouraged by it, but I am reluctant to draw too many conclusions,” Mr. McDonagh said.

HSBC Chief Executive Michael Geoghegan said loan-loss rates could increase again in the third or fourth quarters of the year. “We expected two difficult years in consumer finance over all,” he said.

Given the fact that HSBC is not connected to Uncle Sam’s gardening, I appreciate the honest assessment and “more realistic” prognosis. Miracle Gro may sell well on late night TV, but I prefer a “gardener” who is straight and honest while informing me that it may be a few years before the lawn comes in.

Speaking of lawns and gardening, here’s a shout out to my good friends Rocky and his pop!!

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Banks: What Lies Ahead?

Posted by Larry Doyle on May 12th, 2009 7:34 AM |

If the major money-center banks are neither going to be nationalized nor fail, at least for the time being, then what does the future hold for these institutions? Uncle Sam has provided massive backstops via a number of programs, but a socialized banking system is not consistent with free market capitalism.

Fed chair Bernanke addressed the three major risks — operational, liquidity, reputational — for these institutions moving forward. Let’s address each individually.

1. Operational: While Uncle Sam (Fed and Treasury) has done a lot (some would say too much) for the large banks, he can’t literally run the banks. With no “shadow banking system” (please read “All The King’s Horses and All the King’s Men“), reluctant consumers, and defensively postured corporations, how do the banks manage their increasing level of loan defaults? On top of that, how do they actually grow their business when, by necessity, they are forced to cut their own expenses?

Banks can only “massage” their numbers via the relaxation of the mark-to-market accounting rule for a brief period. While a few of these institutions have large capital market businesses which have recently provided solid returns, those are high risk operations and earnings from that division are volatile. Underwriting fees for new issues of debt and equity were at record lows in the 1st quarter 2009.

Will banks be able to manage their traditional “bricks and mortar” operations (underwriting and holding quality loans) and generate long term growth in this sector? Good question and a real risk.

2. Liquidity: Without Uncle Sam backstopping the short term markets, will banks be able to source sufficient daily liquidity to manage and grow their business units? Bernanke is setting the stage for the time when the Fed needs to drain liquidity from the system so the inflation monkey – if not the hyperinflation monster – does not spin out of control. (please read “Putting The Genie Back Inside the Bottle“)

In layman’s terms, how does the Fed wean the banking system from the drugs that have kept it alive? Will some of the banks be zombie-like, if not outright brain dead? Would we have been better off letting certain institutions fail? If banks can’t source their own liquidity to “live a healthy life,” perhaps Uncle Sam has been more of a benevolent old man when a strict disciplinarian was more in order.

3. Reputational: If banks are challenged to grow and source liquidity without Uncle Sam’s assistance, will they start to cut corners, and once again push the envelope out of desperation for earnings? Please read, “The Greatest Risk,” a recap of the risks undertaken by Bear Stearns, which played a major role in that 100 year old firm’s downfall. Desperate people do desperate things and similarly desperate institutions will also do desperate things. We have already seen ample evidence of extreme measures taken by banks to jeopardize the reputation of the institution in pursuit of the almighty dollar. In this realm, who will be watching? What type of regulations will be implemented and enforced?

On all these fronts, the risks faced by the banks are significant. The risks faced by consumers are also significant. If there is one thing we have learned throughout this ordeal, it is the fact that we can not blindly trust what executives of banks, as well as other institutions, lead us to believe. We must probe, look beyond the numbers, and seriously question the integrity of the data. If we don’t, then we increase our own risks as we navigate our own personal economic landscapes.

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Allen Stanford and Whitey Bulger: Two Peas In a Pod?

Posted by Larry Doyle on May 11th, 2009 2:58 PM |

Allen Stanford and Whitey Bulger

Are Allen Stanford and Whitey Bulger two peas in a pod? For those unfamiliar with Whitey, he is Boston’s greatest gangster, a government informant who simultaneously continued to run his gangland activities, one of the FBI’s Most Wanted, and still on the lam. The Martin Scorsese film, The Departed, was largely based on Whitey and his boys. If Whitey dealt in drugs and murder, is Stanford Financial, operated by Allen Stanford, a financial version of a government cover totally run amuck?

We all know the SEC totally dropped the ball in the oversight of the Bernie Madoff Ponzi scheme. On the heels of that and to alleviate massive pressure on the commission, the SEC quickly moved on Allen Stanford.

MAJOR hat tip to MC of Investor Rebellion in sharing with me a story broken by the BBC, Stanford Drug Informer Role Claim:

Evidence has emerged that the Texan who bankrolled English cricket may have been a US government informer.

Sir Allen Stanford, who is accused of bank fraud, is the subject of an investigation by the BBC’s Panorama.

Sources told Panorama that if he was a paid anti-drug agency informer, that could explain why a 2006 probe into his financial dealings was quietly dropped.

Sir Allen vigorously denies allegations of financial wrongdoing, despite a massive shortfall in his bank’s assets.

But the British receiver of his failed Stanford International Bank – based in Antigua – told Panorama that the books clearly show the deficit.

If in fact this development is accurate, has the U.S. government, via the DEA, facilitated a Ponzi scheme? I am not so naive as to think that there aren’t massive undercover operations ongoing regularly to infiltrate and expose illicit activities. However, if in fact that were the case, how did the DEA lose control of Stanford’s investment activities? Is this situation an indication that the Obama administration will not partake of these types of undercover operations? Is there a massive in-house brawl currently ongoing between the DEA and the SEC?

The BBC reports:

Secret documents seen by Panorama show both governments knew in 1990 that the Texan was a former bankrupt and his first bank was suspected of involvement with Latin American money-launderers.

In 1999, both the British and the Americans were aware of the facts surrounding a cheque for $3.1m (£2.05m) that Sir Allen paid to the Drug Enforcement Administration (DEA).

It was drug money originally paid in to Stanford International Bank by agents acting for a feared Mexican drug lord known as the ‘Lord of the Heavens’.

The cheque was proof that Stanford International Bank had been used to launder Mexican drug money – whether or not Sir Allen knew it at the time.

On 17 February of this year, the US Securities and Exchange Commission (SEC) accused Sir Allen of running a multi-billion dollar Ponzi fraud – when cash from new depositors is used to pay dividends to old depositors – civil charges he has denied.

Two and a half months after the SEC filing, the Texan has not yet faced criminal charges.

He was initially investigated by the SEC for running a possible Ponzi fraud in the summer of 2006, but by the winter of that year the inquiry was stopped.

Is this another version of the Whitey Bulger story in which the criminal turned informant continues to operate his own illicit activities? Whitey is now on the lam and his FBI protection, John J. Connolly, is cooling his heels in a federal penitentiary.

The intrigue of this situation is surreal, but the natural and instinctive question has to be: if Uncle Sam (DEA) provided cover for Allen Stanford in the pursuit of illicit drug related activities, did Uncle Sam also provide cover for Bernie Madoff as well?

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NASD Knew Auction Rate Securities Weren’t Cash

Posted by Larry Doyle on May 11th, 2009 10:45 AM |

Everybody knows Auction Rate Securities (ARS) were cash or cash-like, correct? FINRA certainly did NOTHING to protect investors from the ARS sales and marketing scam perpetrated on investors.

FINRA spokesman Herb Perone would like to wash his hands and those of FINRA of any negligence or incompetence in regard to FINRA’s investments in Auction Rate Securities. The easiest manner of washing one’s hands is to point the finger at the entity which initially made the investment, in this case the NASD (National Association of Securities Dealers). If you recall, FINRA was formed in mid-2007 from the regulatory arms of the NYSE and NASD. In any event, Perone tries to deflect culpability on FINRA’s part in the recently reported Bloomberg story (FINRA Oversees Auction-Rate Arbitrations After Exit) highlighting FINRA’s sale of their Auction Rate Securities prior to the market’s implosion leaving thousands of investors and billions of dollars frozen. Bloomberg reports:

“The market was functioning normally when NASD was investing in these securities,” Perone said. At the time, auction-rate securities “were viewed as high-quality cash equivalents and as acceptable investment for institutions,” he said.

Perone further offers:

“It was for cash that we needed to have parked for a temporary period of time,” Perone said. “It was common to take cash you needed to hold and put it in auction-rate securities.”

If ARS were viewed as high-quality cash equivalents, why didn’t the NASD actually account for them in that manner? The NASD goes out of its way in its Annual Reports for 2003-2005 to highlight the fact that ARS were not cash or cash-like.

From page 38 of the NASD’s 2005 Annual Report, published on May 10, 2006:

Available-for-sale investments also include investments in auction rate securities, which are either preferred stock or bonds with interest rates that reset periodically, typically less than every 90 days, based on a Dutch auction process. Given the longer-term maturities of these securities, they are classified as available-for-sale investments, rather than cash and cash equivalents.

From page 30 of the NASD’s 2004 Annual Report, published on April 29, 2005:

Available-for-sale investments also include investments in auction rate securities, which are either preferred stock or bonds with interest rates that reset periodically, typically less than every 90 days, based on a Dutch auction process. Given the longer-term maturities of these securities, they are classified as available-for-sale investments, rather than cash and cash equivalents.

From page 27 of the NASD’s 2003 Annual Report published on June 7, 2004:

Available-for-sale investments also include investments in auction rate securities, which are either preferred stock or bonds with interest rates that reset periodically, typically less than every 90 days, based on a Dutch auction process. Given the longer-term maturities of these securities, they are classified as available-for-sale investments.

I have been questioning whether FINRA was negligent, incompetent or both in regard to their investment in ARS. FINRA could not have been negligent. Their parent organization, the NASD, lays it out in three separate Annual Reports that ARS were not cash or cash equivalents.

Thus, FINRA was merely incompetent in not protecting investors, as is its mandate!!

How may this be adjudicated? It is now speculated that Uncle Sam may establish a liquidity facility which investors can tap to get their money. This liquidity facility may be part of a larger government entity. I do hope this facility is enacted and that ARS investors can receive a timely return of their funds.

However, to whom does the obligation and cost shift? The American taxpayer. Once again, the taxpayer may pick up the tab for an activity (the sales and marketing of ARS by banks and investment managers) deemed a fraud by federal judges.

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