PIIGS: Too Big to Fail

The largest economy in the world, The United States of Europe, officially called the European Union is facing a financial crisis that could weigh down our own economic recovery.  The bears on Wall Street have outnumbered the bulls, focusing on the economic upheaval in Europe instead of the good economic news here at home.  Economic indicators here in the U.S. are still pointing upwards indicating the continuation of our recovery from the great recession.  Housing starts rose an estimated 5.8% in April to an annual rate of 672,000; retail sales were up 0.4% beating expectations; industrial production moved higher; 1st quarter earnings of 75% of companies in the S&P 500 have exceeded expectation and most notably, the private sector added 32,000 jobs according to ADP.  Various economists differ in their projection of job growth this year, from a low of 300,000 to a high of 1 million private sector jobs.  I believe that the extension of unemployment and health benefits is a disincentive for many unemployed workers to seek work, thereby contributing to the high unemployment rate which has been hovering around 10%.

The malaise in Europe is hard to ignore because our global economies are all inter-connected.  The failure of any of the EU’s most ailing economies, the PIIGS which is an acronym for Portugal, Ireland, Italy, Greece and Spain could send a tsunami of global economic woe: a financial meltdown much worse than the sub-prime mortgage crisis of 2008.  The PIIGS are less affluent countries than their northern neighbors such as Germany and France and there is such a disparity of wealth between member nations.  The IMF/European Debt Bailout of 750 billion Euros, which has been nicknamed “Le TARP”, pacified the market early last week so the bulls started running again driving up the Dow Jones Industrial Averages (DJIA) 500 points from the previous week’s low of 10,380.  As reality sank in, investors became jittery and gravitated towards tangible investments such as gold, driving up its price to $1220 an ounce.

Reality is that Greece will eventually default.  It is my educated opinion based on facts.  Greece is the second most corrupt developed country in the world according to Forbes Magazine.  It is easy to bribe Government officials.  It is a social democracy, a welfare state with generous entitlement programs which includes early retirement, state pensions, and huge bonuses for public employees and a generous cradle to grave health care system.   The wealthiest members of society, shipping magnates like Onassis, lawyers, doctors and other highly paid professionals have traditionally avoided paying direct taxes.  I do not think the Greek populace can swallow the austerity measures being currently debated by the Greek parliament.  Public anger in Greece will continue running at explosive levels. Why should the Greeks agree to do away with their entitlements which have been their way of life for such a long time?  Besides, most Greeks do not blame themselves nor their government for their predicament.  Rather, many Greeks would argue that the U.S. caused the financial meltdown leading to the severe world wide recession and banking crisis. Greece’s accumulated deficit is running 113% of GDP.  They have ran out of money to pay for their bonds that are coming due.  The solution is to issue more long term bonds to raise money but their government bonds have been downgraded making it impossible to sell them to continue to finance deficit spending.

Austerity measures being proposed include the freezing of government pay till 2014; dispensing with the 2-month bonus for public employees; increasing of the retirement age from 61 to 63; increasing VAT (Value Added Tax) from 19 to 23%.  It is reported that 1/3 of the Le TARP money or 250 Euros will come from the International Monetary Fund (IMF) out of which 10 billion Euros is the contribution of the U.S.

Volcker’s statement last week that the Euro may break up, points to the core of the problem of the European Union. The Euro has gone down from its high of $1.50 per Euro last November to a low of $1.24 this week.   The problem is that on one hand, member countries have become financially responsible for each other as magnified by this crisis.  On the other hand, member countries have very little influence on how another country is governed because each member is an indivisibly sovereign state. At least if Greece goes back to its own currency, the drachma, it will suffer on its own for its fiscal irresponsibility.  This current crisis is testing the EU if it can stay united and if the Euro will be preserved.

The 750 billion Euros may not be enough to rescue Greece.  It certainly will not be enough to bail out other PIIGS in case any of them defaults on their external debts.  If one falls, it would be followed by another and another and another.  And this is what worries me and makes me bearish on the market despite the good economic reports in this country.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein.

Any opinions and views expressed herein are the sole responsibility of the writer.

BUSH-OBAMA Recession, No Different from the Rest

Many economists, prognosticators, financial pundits, stock brokers and financial planners have committed a big blunder or a big hoax by proclaiming this recession different from the rest and the worst since the great depression.  The fact is I believe this recession is no different from the previous post war recessions.  Those who share my belief have made a lot of money in the stock market during this recession.  In the first quarter of this year, the majority of financial pundits I watched on TV advised investors, some of whom have already lost 50% of their savings at that time,  “to stay out of the market” unless they have 10 or more years to go before retirement.  Who knows how many took their advice and got out of the market, thereby missing the bull market that started in March and is still going strong as of this minute.   In January and February, many financial experts were predicting the Dow Jones Averages to go down to 5,000.  In “DIDOSPIN-11,000 DOW, August 7, 2009” when DJIA was 9,370, I predicted the Dow to climb to 10,000 before the end of the year and to 11,000 before the end of next year.  It already reached 10,000 last week. Most of the financial experts I watched on the Lou Dobbs and Larry Kudlow shows collectively stated that “it may take 10 years to recover losses in retirement plans…”   Shame on them for being so incompetent or for perpetrating a hoax!   Those investors who stayed put have already gained back most of what they have lost and I believe this bull market still has legs before the next significant market correction.

In “DIDOSPIN- Obama’s Recession, March 8, 2009”, I said “Recessions are part of a normal economic cycle.  Soon consumers will come back and resume buying necessities such as refrigerators, TVs, computers, furniture, cars…”  How true!  A lower than expected contraction in GDP at 1% in the 2nd quarter is believed to have been followed by a small positive increase in GDP in the 3rd quarter, although official stats have not yet been released.  I predicted a much bigger increase in GDP the 4th quarter.  The increase in GDP is an indication of an increase in consumer spending.  One thing to remember is that GDP stats do no even take into consideration business to business consumption, only the consumption of the ultimate consumer or end-user.  This is something that many people are not aware of. 

I secretly scoffed at my boss in January when he told me in a panic that we must dig in our heels in this “worst ever recession”.  I told him, “We’ve seen this before, the last one in 2001….” “No, no, no”, he adamantly replied, “this is different”.  How wrong he was!  The only difference between this recession and the previous ones is its nickname.  This one will probably be known by several nicknames such as “Sub prime Mortgage Crisis, aka Housing Bubble Burst, aka Auto Industry Crisis Recession”.  The various nicknames of the 3 previous recessions according to Bloomberg News were:  Dot-Com Bubble Burst – 2000 to 2001; S&L Crisis, 1990 to 1991 and the Energy Crisis Recession, 1981 to 1982.

I concede that this will prove to be the longest recession since the Great Depression.  But its severity and misery index pales in comparison to the Carter-Reagan recession.  According to Bloomberg News, during the 1981-1982 recession, the national unemployment rate was 10.8% at its highest; inflation was 14% and the prime rate went up to 20.5%.  In this current recession, inflation is almost non-existent and the prime rate is the lowest it has been in 50 years (source:  http://www.wsjprimerate.us/wall_street_journal_prime_rate_history.htm).

Obama predicted the unemployment rate will continue to increase and will exceed 10% before the year is over but I will go with my prediction in “DIDOSPIN- Recession Over, June 27, 2009” that it would peak at 9.8%.  This means that more than 90% of the working population is employed and is poised to go back into the “buying mode”. It is a cycle and consumers eventually buy what they need or want. The stock market rally is a big factor in consumer spending.  If a consumer sees his portfolio going up in value, he will have more confidence spending his discretionary income as opposed to saving it for a rainy day.  Fortunately, the behavior of the stock market follows a free market pattern that is predictable.  The stock market does not like government intervention in the free market economy.  It does not like redistribution of wealth; tax increases; government take over of health care, the banking system and other private industries; cap and trade; interest hikes and increase in deficits.  One of the reasons the market is doing so well is that Obamacare and Cap and Trade appear to be in trouble.  There are different versions of Obamacare bills that are still under discussion in the congressional committees, and although Cap and Trade bill passed the house, it is not expected to pass the senate.  If these two bills regain traction, it is almost guaranteed that the market will take a plunge, perhaps causing a double dip recession.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein.

Any opinions and views expressed herein are the sole responsibility of the writer.

Recession Over

Despite Obama’s pronouncements of a rough second half of the year, I declare this recession officially over.  I looked at the stock market movement, the Dow Jones and NASDAQ averages, and I conclude that the 50 to 200 day market activity indicates an upcoming bull market.  Oh yes there will be ups and downs and sideway turns in the market but all in all this will prove to be a bull market.  Durable goods orders have been up 3 out of 4 months, corporate capital expenditure is up, and consumer confidence is starting to soar both in housing and in big ticket items.  The Fed’s policy of keeping the prime rate low in spite of an inflated money supply should hold down inflation for at least a year or two.  Relatively low energy prices should also help temper inflation.  Housing affordability is an all time high.  I predict that the third quarter will show a small gain in the GDP followed by a much larger gain in the 4th quarter.

At this point, I like the tech stocks sector, natural resources and developing market sector.  You can invest 10 to 15% of your holdings in real estate securities if you do not mind the volatility and if you can play with this portion of your holdings for the next 2 years.  The real estate sector has been beaten up so badly that it can only go up.

What I do not see improving is the value of our currency.  The U.S. dollar will continue to be tested because of the unprecedented Obama budget deficits and the massive trade deficits particularly with China.  The unemployment rate is a toss up.  I do not have much of a quarrel with Obama’s declaration that it would go up to over 10% before year end, but my prediction is that it would peak at 9.8%.

What does this all mean for the Republican Party?  Bad news.  In this instance, the free market economy will prove to be an ally of Obama because despite Obama’s incessant attack on capitalism, like redistribution of wealth and the take over the health care system, the free market economy will prove to be so resilient in the face of such an assault that it will remain true to its usual pattern of “a long period of feast and a short period of famine”.  Timing is everything and it appears that Obama’s timing is perfect, almost heaven sent.  2010 should be the start of a full economic recovery and 2012 should be a year when the economic recovery gets into full swing.  I am still hoping though that voters will have enough sense to vote Harry Reid, Chris Dodd, Barney Frank and Nancy Pelosi out of their respective offices.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein.

Any opinions and views herein are the sole responsibility of the writer.

Scrap Mark to Market Valuation

The key to unfreezing the credit markets is the scrapping of Mark to Market Valuation. Because of the U.S. Generally Accepted Accounting Principles (GAAP) bank assets are valued at Mark to Market.  Many of these assets, Mortgage Backed Securities (MBS) and other derivatives have drastically dropped in value because of this method of valuation.  The Treasury Department and the SEC have branded these types of assets as toxic.  However, the reality is that many of these so-called toxic assets are still earning the same return as when they were first bought by the financial institutions.  Therefore, even if a bank is very profitable it may not pass the Feds’ stress test, and the Feds may opt to re-capitalize it with bail out money thereby subjecting it to compensation and bonus restrictions.  A bank may be considered by the Feds as a troubled institution even if it is drowning in money.

An alternative method of valuation which many economists are now advocating is the Cash Flow Method.  As a simple explanation, the Cash Flow Method of valuation takes into consideration how much income the company receives from the so-called toxic assets rather than how much those toxic assets are presently worth.  If this valuation method is used, financial institutions will start lending again because they will show a stronger balance sheet, presumably taking them off the government hit list of troubled financial institutions.

Geithner’s “plan” which was revealed yesterday is a hybrid of the solution I proposed in DidoSpin 03/08/09.  It appears that the government will indeed create an entity to buy toxic assets (MBS).  The difference is that the government will solicit investors from the private sector to partner with in buying the assets.  With $1.25 trillion to spend, the government, in partnership with private investors hopes to acquire the assets at close to their toxic asset prices.  Obviously the banks will try to get as much money as they can for them.   This is a win-win situation because the banks’ stocks will increase in value as soon as the toxic assets are sold and when the housing market recovers as it always does the government’s holdings will increase in value and the government will make a hefty profit.  If Wall Street is in favor of the “plan” and liberals are against it, then I am for it.

Any opinions and views herein are the sole responsibility of the writer.


Bank Stress Tests & Other Terms

The political talk shows this past weekend generated lots of economic, financial and accounting terms such as Bank Stress Tests, Mark to Market Valuation, Cash Flow Valuation, Positive Yield Curve and 3rd Tier (Capital) Assets to name a few.  I wonder how many viewers understood those terms.  I would like to take this opportunity to simplify them for the reader.

The bank stress test is what the Treasury Department will conduct on banks and other financial institutions to determine which institutions are undercapitalized and whether they have enough reserves to weather adverse scenarios such as the rise and fall of the stock market, interest rates and currency fluctuations and exposure to undisclosed risks.  Initially the Obama Administration indicated that the stress test would only apply to financial institutions with over $100 billion in assets, but due to the worsening economic outlook, all bets are off.

Mark to market valuation is the current FASB (Financial Accounting Standards Board) and SEC (Securities and Exchange Commission) standard of valuation of bank assets.  As an example, if Citibank is holding a mortgage derivative which was valued at $600,000 before the bubble burst, but is now only $200,000, regulations require the bank to report this asset (Capital) at Mark to Market which is $200,000.  If the bank is holding many of these derivatives, Geithner’s office may declare the bank as “in distressed” and force it to take additional capital from the government in bail out money.  Many economists such as Larry Kudlow and Lou Dobbs now advocate the Cash Flow Valuation instead of  Mark to Market on the ground that the $600,000 asset still yields the same return for the bank although it is now only valued at $200,000.

The Positive Yield (interest rate) Curve is the normal yield of investments.  Longer term maturities usually have a higher yield than shorter term.  When the yield becomes negative or inverted, it spells trouble for the banking system as what started happening in late 2006.  The incentive for depositors to leave their money with the bank for longer periods of time, say 5 to 10 years is to earn a higher interest rate.  If the interest rate is the same for 5 years as it is for 1 year, this incentive is gone.  Geithner’s job now is to classify banks’ assets into tier 1, 2 or 3.  If Geithner’s agents reclassify too many of a particular bank’s assets from tier 1 to tier 3, that bank may be classified as a distressed bank and may be forced to take bail out money as additional capital.  Tier 3 assets or capital are the most risky investments the bank holds.  Examples of these are uncollateralized debts such as credit card debts and unsecured personal and business loans.

What we have seen from Bush and Paulson to Obama, Geithner and Pelosi is that our government tends to overreach in its desire to restore stability.  The Obama administration goes one step further by taking advantage of the crisis to put through its social agenda.  As Rham Emmanuel clearly stated, “we should not let a crisis go to waste.”   As recently as a week ago, many banks including Citibank and Bank of America announced that they are not in bad shape; that they are actually making money; and that they don’t need any more government bailout money.  I hope, for our own good, that such announcements and the positive yield curve will prompt investors to pull their cash out of their mattresses and home safes and hand it over to their friendly neighborhood bank.

Any opinions and views herein are the sole responsibility of the writer.

The Obama Recession

According to the Wall Street Journal, there have been 11 recessions in the United States since World War II.  These recessions lasted between 8 months and 2 years, the longest being the Carter-Reagan recession.  This Bush-Obama recession has a potential for lasting longer than that.  I believe this because the Obama Administration appears to be in a state of chaos.  It is sending mixed messages and appears to be playing it by ear, making adjustments as it stumbles along.  If Obama is having problems dealing with the economic crisis, I shudder to think how he could deal with an international crisis if one develops.

If Obama allocated the bulk of the $800 billion stimulus package to tax cuts and in rebuilding infrastructure and schools, as I thought he would, consumer confidence would have gone up.  Instead, a big chunk of the stimulus package is going towards pork barrel spending.  To make matters worse, the Obama Administration is talking about taxing the rich, those making over $250,000 by removing the taxable income limit for Medicare Tax and limiting the mortgage and charitable contribution deductions.  Geithner does not even have a deputy secretary yet.  He appears to be working alone, formulating policy and making anti free market suggestions that the Administration will increase taxes on capital gains, corporate profits and foreign investments.  There is no doubt in my mind that the stock market plunge of over 3,000 points in the Dow since the election is a direct result of investors’ lack of confidence in the Obama Administration.  When retirement accounts lose 50% of their value, consumers get scared and postpone spending.  It so ironic that China, a communist country has no capital gains tax which must be the primary reason their stock market has recorded the highest gains this year.

When will the left wing radicals learn that taxing the rich will hurt the poor people more?  The rich are the ones who eat at expensive restaurants, go on vacations, buy luxury items and employ people.  I am not rich but I do not envy the rich because my goal is to get rich myself.  We all have an equal opportunity to acquire wealth in this country provided the government does not stand in our way.

Our free market economy will recover despite Obama.  Recessions are part of a normal economic cycle.  Soon consumers will come back and resume buying necessities such as refrigerators, TVs, computers, cell phones, furniture and cars.  42% of stocks in the S&P 500 gained since the beginning of the year.  Energy costs have only increased a little bit since sinking to their lowest level last December.  According to the Los Angeles Times, the highest concentration of foreclosures and decline in property value are in 5 states; California, Nevada, Florida, Michigan and Ohio.  90% of homeowners are still paying their mortgages on time.  The dollar has recovered nicely against major foreign currencies which means anything we import is costing us less.  Still, stumbling and uninspiring Obama can prolong this recession by talking down the economy.

If Obama and his cabinet members are listening, I have a sure fire way of ending this recession immediately.  Geithner has no plan yet on how to use the $300 billion allocated to fix the banking system.  So these are my suggestions.  1) Announce the formation of RTC2 (Resolution Trust Corporation) to take over toxic assets from ailing banks.  This move is similar to what solved the Savings and Loan crisis of the early 90s.  This will restore confidence in our banking system.  2) Announce the reduction of the capital gains tax from 28% to 7%.  This will attract local and foreign capital back into the stock market which would increase the value of stocks.  3) Announce the reduction of corporate tax from 34% to 10%.  This will stimulate business activity and companies will start hiring again.

What are the chances that the Obama Administration will follow my advice?  I will not hold my breath.  They are a group of ideological left wing intellectuals who have their own agenda of equal wealth distribution and of government intrusion into our lives.  Therefore let us prepare ourselves for more pain and say hello to the Obama Recession.



How We Got Here, Market Crash of 2008, Housing Bubble

I am worried just like many investors that Obama and his cabinet members do not know how to fix our present economic problems.  That is the reason, many investors have been continuing to dump stocks and pretty much keep their cash underneath their mattresses.  What is worse is that Obama and crew as well as many legislators do not seem to know how we got here.  If we do not know how we got here, how will we know how to get out?

Obama: Well, first of all, I don't think it's accurate to say that consumer spending got us into this mess.  What got us into this mess initially were banks taking exorbitant, wild risks with other people's monies based on shaky assets and because of the enormous leverage, where they had one dollar's worth of assets and they were betting thirty dollars on that one dollar, what we had was a crisis in the financial system….. My bottom line is to make sure that we are saving or creating 4 million jobs, we are making sure that the financial system is working again, that homeowners are getting some relief…..

Question: Thank you, Mr. President.  Many experts, from Nouriel Roubini to Sen. [Chuck] Schumer, have said that it will cost the government more than $1 trillion to really fix the financial system. During the campaign, you promised the American people that you won't just tell them what they want to hear, but what they need to hear.

Won't the government need far more than the $350 billion that's remaining in the financial rescue funds to really solve the credit crisis?

Obama: Well, the credit crisis is real, and it's not over.  We averted catastrophe by passing the TARP legislation.  But, as I said before, because of a lack of clarity and consistency in how it was applied, a lack of oversight in -- in how the money went out, we didn't get as big of a bang for the buck as we should have.

-end of news conference-

If I go by Obama’s first news conference, it is clear that he is not sure how we got HERE and how we are going to get out.  This is very reminiscent of the Carter Administration.

First, let us make it clear that Republicans tried to fix this problem (banking crisis) which the Democrats helped create through the creation of the CRA, Community Reinvestment Act.  In 2005 Republicans tried to reign in Fannie and Freddie.  The Senate Banking Committee passed a serious Fannie and Freddie reform bill, S.190, that would have required Fannie and Freddie to eliminate their investments in risky assets.  (See http://www.govtrack.us/congress/billtext.xpd?bill=s109-190).  As co-sponsor of S.190, Senator John McCain warned of the forthcoming economic crisis.  But the bill failed in the senate.

Foreclosures started increasing in 2005 due to the fact that sub-prime mortgage borrowers could no longer afford their monthly payments.  Many of these loans were NINJA (no income, no job, no asset) loans offered by banks to under-qualified borrowers who were willing to pay a premium interest rate and mortgage insurance to qualify.  Some were balloon mortgages with no interest for the first few years.  When mortgage rates went up from a low of approx 3.5% in May 2003 to more than double that in mid 2006, many homeowners just abandoned their houses.  This was the primary cause of the banking crisis, the “financial meltdown” as Obama refers to it.

The recession accelerated sharply due to the energy crisis of 2007-2008 with $4 per gallon gas and $140 per barrel oil.  This energy crisis like the specter of death reached all across America strangling many businesses.  The recession increased foreclosures and bailout mania followed.

It is interesting to note that Obama and Geithner do not seem to know where the first part of the bailout (TARP) money went.  It is like this Mr. President:  Let’s say BANKONE takes in a one year time deposit of $1000 from John promising to pay him 3% interest per annum.  Then BANKONE lends $1000 to Peter for a period of one year at 7% interest rate.  Nice profit.  But at the end of one year, Peter has lost his job and can only pay $500.  But now John wants his full $1000 plus interest.  The bank does not have the money.  Where will he get it?  From the government.  That is how the first part of the bailout money is being used.  The banks simply deposited the money and entered it on their balance sheet, i.e. debit cash and credit loan from the government.  They are being over cautious and prudent as well they should be in their lending practices because the opposite is what got them into this mess in the first place.  Now Obama, Geithner and the democrats are asking where did the TARP money go?  Why are the banks not lending money?  Where is the help for the homeowners?

Finally, another interesting observation is that bailout mania appears to have pervaded our free market system and even our entire society seemingly making us ripe for a transition into something like European socialism.  Bailout for the auto industry, health care industry, the states, auto rental companies, adult entertainment industry, etc.  A woman during one of Obama’s town hall meetings even wanted a personal bailout….a new kitchen, a new car.

My neighbors and I, about 8 of us, are getting together this weekend so we can put together a plan for a bailout of our own from our banks which hold our home mortgages in our subdivision.  We found out that the bank reduced the principal owed by one of our neighbors from $795,000 to $400,000 because he had been 6 months late on his mortgage payments and he can only afford amortization payment on $400k.  Meanwhile, the 8 of us who have about the same mortgage balances have been paying our mortgages on time.  The bank says, “no bailout for you unless you are delinquent on your mortgage payment”.  Well, we do not want to be delinquent but we want some of that bailout money!