ValuePlays

Chart, Fox, Fat tax, Vets

– Too good to be true.

– Overkill

– Would be funny if it wan’t true

– Sears takes care of them

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No one is spared in this one….no one..

Part 1: “2009 is the Year of Stagflation for the globe”

Part 2: “Regulators were asleep at the wheel”

Part 3: “Significant sources of financial stress still coming up”.

Disclosure (“none” means no position):
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Um…….Sadly, I think he may be right. It does bode well for large caps though. A sluggish economy will crush the smaller firms and startups as credit tightens ans results are muted. I think the play here is buying the monsters in sectors..

Here is a great interview with Henry Blodget and Aaron Task from today:

Now, here is Schilling report:

Semi-Annual U.S. Economic Outlook: Collapsing On Schedule
by Gary Shilling

The recession is now running on all four cylinders. We’re referring to the four phases of the downturn that we identified much earlier and discussed in numerous Insights.

Phase 1, the collapse of the housing sector, touched off by the subprime slime, as we dubbed it, and measured by the ABX BBBindex, started early last year with the $1.8 billion writedown of subprime mortgage securities by big U.K. bank HSBC in February. Phase 2, the spreading of the woes to Wall Street, commenced with the implosion of two big Bear Stearns hedge funds in June 2007. These first two phases are largely financial, and persist today.

Housing Horrors

Housing starts have nosedived from 2.3 million, seasonally adjusted at annual rates, in January 2006 to 791,000 in October, a post-World War II low (Chart 1). Meanwhile, homebuilder sentiment is now at record lows. Leaping foreclosures, among other forces, have pushed up the homeowner vacancy rate. Some of the victims of declining homeowner rates are moving into rental apartments as the bubble years’ lure of homeownership fades or they lose their houses. But others are doubling up with friends and family, thereby adding to empty house inventories.

Foreclosure Sales

As lenders spilled foreclosed houses on the market, they were sold for only 70% of the unpaid loan balance in the third quarter compared with 78% in 2007, and losses averaged 44% of the loan balance compared with 29% a year earlier. With about 40% of existing home sales coming from foreclosures, or “short sales” in which the mortgage amount exceeds the house’s value, the prices for selling homeowners and builders are forced to decline to compete.

25% More

Existing home prices are down in October 20% from their peak in October 2005 as measured by the National Association of Realtors, and 21% from their second quarter 2006 peak according to the less-upward biased Case-Shiller index (Chart 2). Curiously, a survey found that in the second quarter, 62% of homeowners believed their houses had appreciated in the last year even though 77% had fallen over that time and only 19% had risen, according to Zillow. Another survey found that 91% believe that a house is the best long-term investment. A third poll revealed that 32% think this is a good time to buy stocks, but 51% believe it’s a good time to invest in a home. We wonder if that optimism will persist if our long-held forecast of a 37% peak-totrough decline holds.

Underwater

At present around 12 million homeowners, a quarter of those with mortgages, are underwater with their houses worth less than their mortgages. Among those who bought their homes in the past five years, 29% are underwater. If our forecast of a 37% house price fall is reached, about 25 million, or almost half the 51 million with mortgages, will be underwater. Adding in the 24 million who own their houses free and clear, and one-third of the total will be in trouble. The destruction of the American Dream of homeownership for so many people will force a political response, even though the cost of subsidizing their mortgages down to their house values would be about $1 trillion.

Financial Problems

The woes of financial institutions also persist, fed by bad mortgages and increasingly by other troubled assets. The extreme stress on the financial system here and abroad is manifested in two clear ways: first, the consolidation and disappearance of many previously impregnable financial institutions and second, by the need for huge and continuing government bailout in order to preserve the integrity of the financial structure and, hence, the world’s economies.

The list of the departed is well known: Bear Stearns, WaMu, Lehman and Wachovia disappeared while Merrill Lynch arranged a shotgun marriage with Bank of America and Morgan Stanley and Goldman Sachs converted to the safety of bank holding companies.

The FDIC recently announced that the institutions it insures had only $1.7 billion in earnings in the third quarter, down from $28.7 billion a year earlier. And financial troubles aren’t confined to banks. Many hedge funds have suffered huge losses on their highly leveraged positions this year. And their sales of securities to limit further losses and to meet investor redemptions are adding downward pressure on many markets. In some, assets are down 50% while others are folding their tents and still others are limiting redemptions, only adding to investor restiveness. Redemptions are expected to jump early next year.

Diversification

Many endowment and pension funds have been hard hit, especially those with heavy alternative investments in hedge funds, private equity funds, venture capital, commodities, currencies, emerging market stocks and bonds, real estate, junk securities, etc. Diversification is a great idea — if it works! But as we’ve noted continually in Insights for more than 10 years, there are tremendous amounts of hot money flowing around the world. And whether it’s managed on the basis of fundamental factors, momentum, technical analysis, etc., it all tends to end up on the same side of the same trade at the same time.

So when stocks get clobbered, as they have since October 2007 (Chart 3), and force out hot money, it will also retreat from otherwise unrelated long positions in, say, grains, to conserve capital. Many institutional investors believe in the Modern Portfolio Theory of diversification, but erroneously thought that alternative investments would have zero or better still, negative correlation with their basic equity holdings. They also became convinced that commodities and foreign currencies were asset classes like equities and bonds, and merited 5%, 10% or 15% of their portfolios. They’re learning the hard way that all those correlations have proved to be close to 100% and that commodities and currencies aren’t asset classes but speculations.

The Overarching Reality

Washington policymakers do not appear to have understood the overarching reality — the massive and painful deleveraging of the immense leverage accumulated by the household and private financial sectors over the last three decades (Chart 4). They were also initially preoccupied with a philosophy of non-intervention in the private sector and with concerns with creating moral hazard if they bailed out troubled financial institutions. Furthermore, they’ve been making up the game plan as they go along. Last summer, Secretary Paulson told Congress that the $700 billion bailout money would be used primarily to buy troubled mortgages and mortgage-related securities from banks. Somehow, that would encourage banks to resume lending, but we never understood how.

A TARP For All

Even though the majority of the $700 billion TARP money is yet to be committed, that total is only a small piece of the $4 trillion-and-counting sum the federal government has made to bail out the financial sector.

Included in that total beyond the $700 billion TARP program is $350 billion in FDIC guarantees on bank-issued debt, and Goldman Sachs, JP Morgan Chase, Morgan Stanley and Bank of America quickly raised $26 billion with Citigroup and Wells Fargo planning to follow. Then there’s an estimated $1.3 trillion from the Fed to buy frozen commercial paper, $540 billion to buy commercial paper and other short-term debt from money market funds to stop the run on them, the new $200 billion Term Asset-Backed Securities Loan Facility (TALF) to back credit card, auto, student aid and small business loans and the $600 billion to buy mortgage-backed securities and GSE debt.

Worst Since The 1930s

Of course, in what will probably be the worst financial crisis and deepest recession since the 1930s, it’s not surprising that Depression-era bailout structures are being copied. The Reconstruction Finance Corp., instituted by President Hoover in 1932, bought positions in over 6,000 financial institutions to the tune of $50 billion, not adjusted for inflation or the growth of the economy since then. The government got senior voting rights to control these firms and barred dividend payments to shareholders until the government was repaid.

The worldwide recession is redirecting sovereign wealth money homeward. For instance, seven sovereign wealth funds in the Persian Gulf region are expected to lose 15% of their value, or $190 billion, this year, cancelling the likely $198 billion growth in crude oil revenues.

It’s interesting that the Fed, with its new commercial paper program, is lending directly to nonbank corporations for the first time since the 1930s. But then the Fed can lend to anyone, you included, under “unusual and exigent” circumstances. The Fed is, after all, the nation’s lender of last resort.

And don’t worry about the remaining $370 billion in TARP money being committed. Detroit automakers want $25 billion. Homebuilders want money from somewhere for their $250 billion bailout, mentioned earlier. Banks not included in the initial nine to receive TARP money in the form of preferred stock purchases worry that if they don’t ask to be included, they’ll appear too weak to qualify. Many of the nation’s 6,000 small, non-publicly traded banks want their share of the government goodies even though they can’t issue preferred shares and warrants.

Spreading Financial Woes

As consumers retrench and eliminate discretionary spending, they are increasingly regarding monthly payments on credit cards, auto, student and home equity loans as discretionary. When it’s a choice between putting food on the table or making a credit card payment, financial responsibility is suffering. Delinquencies and charge-offs in these consumer loan categories are mounting with a 9% increase in auto loans 30 days past due in the second quarter vs. a year earlier and an 11% rise in those 60 days overdue.

Even upscale-oriented American Express, where over half its revenues come from fees paid by merchants, is suffering as charge volume falls and delinquencies and charge-offs on its credit cards rise, leaping 6.7% in September from 3.6% a year earlier. Consequently, the firm recently became a bank holding company so it could qualify for TARP money and hopes to get a $3.5 billion infusion. Credit card issuer Capital One has received preliminary approval for $3.55 billion in TARP money. Credit card issuers are also reacting to weakening volume and jumping charge-offs by raising interest rates and fees.

Student loans more than doubled from $41 billion in school year 1997- 1998 to $85 billion in 2007-2008, but almost all of the growth was in private loans, with subsidized federal aid relatively flat. And delinquencies are jumping in that segment. SLM, or Sallie Mae, the largest private student lender, reported a delinquency rate of 9.4% in September vs. 8.5% a year earlier. Parents, suffering from stock losses and the disappearance of home equity, are no longer able to bail out their debt-swamped offspring. Meanwhile, SUV and other vehicle owners who are now upside down on their auto loans due to weak used vehicle prices have limited zeal to keep up on loan payments.

TALF

Adding the general freezing of credit markets to these conditions and it’s not surprising that investor buying of securitized consumer loans, which normally provide the funds to make fresh loans, has dried up. In October, there was only one $500 million deal compared to $50.7 billion a year earlier. And the interest cost has leaped. From June to October, the risk premium on a triple A credit card deal jumped from 3.2 percentage points over 2-year Treasurys to 4.67. Treasury Secretary Paulson recently said that that market “is currently in distress, costs of funding have skyrocketed and new issue activity has come to a halt.”

So the government bailouts that we predicted in our October Insight have commenced. The Department of Education is buying $6.5 billion in federally-guaranteed loans, which doesn’t affect troubled private student loans directly but does bolster the student loan market overall.

Much more importantly, the government in late November initiated the Term Asset-Backed Securities Loan Facility (TALF) under which the New York Fed will extend up to $200 billion in nonrecourse loans to holders of asset-backed securities backed by highly-rated auto, student, credit card and small business loans. The program may be expanded later to include commercial and residential mortgage-backed securities. The Treasury is kicking in $20 billion from TARP to absorb any losses, as noted earlier.

The hope is that this $200 billion infusion will re-ignite consumer loans. But, as discussed in our October report, leaping delinquencies and the eventual huge writedowns by financial institutional holders of bad consumer loan-related securities suggest that the zeal for consumer loans on the part of lenders or investors will remain subdued. Like TARP, TALF is likely to be no more than a bailout for distressed lenders who made a lot of bad loans. Since the Nov. 25 announcement of TALF, yields on bonds backed by credit card and auto loans remain at record levels.

Foreign Financial Woes

Phase 2 of the recession, financial woes, are, of course, a global phenomenon. And so are the responses. The U.K. initiated the direct injection of government money into banks to buy preferred stocks. The British government had hoped to attract some private capital into HBOS and Royal Bank of Scotland, but collapsed share prices left the government with most of the new stock. Barclay’s avoided government help, but with its stock down 70% this year, it may ultimately end up with a third of the bank owned by Middle East investors as it raises $10 billion. The Bank of Japan is injecting another $32 billion into the financial system by expanding lending and easing collateral requirements.

Switzerland depends heavily on her reputation as a super-safe haven for international money, and her financial services industry contributes 11.4% to GDP and employs 5.9% of her workforce. Yet the condition of her banks has deteriorated to the point that in October, her Economics Minister had to state publicly that the government would not allow big banks UBS and Credit Suisse to fail. The government is injecting $5 billion into UBS to back $50 billion in illiquid UBS assets. That bank has suffered over $40 billion in losses due to bad mortgage-related securities.

Credit Suisse is in better shape but suffered a $2 billion third quarter loss due to writedowns on mortgage securities and unsold buyout loans as well as currency trading losses. The bank still holds $26 billion in leveraged loans and conventional mortgagerelated securities. Both banks are closing their bond funds for outside investors due to huge withdrawals following losses.

Meanwhile, the Netherlands agreed to inject $13 billion into the banking and insurance giant ING. In 2000, the Spanish central bank introduced its “dynamic provisioning” system that required Spanish banks to build up considerable reserves against potential future losses. As a result, Spanish banks began this year with 200% coverage of nonperforming loans compared with 59% for the average EU bank in 2006. Still, Spain recently set aside $41 billion to fund illiquid assets of her banks. And turbulent market conditions prompted Banco Santander, Spain’s largest bank, to unexpectedly announce last month a $9 billion rights issue.

Russia has been floating on a sea of crude oil, but has sunk along with oil prices. Russians are fleeing the ruble for dollars and $83 billion left the country from August to October. The government has raised interest rates and spent heavily to cushion the currency’s descent and avoid a repeat of its 1998 collapse. Still, the ruble is down 5% from its August high, and a halving of its current value is forecast. Meanwhile, plunging crop prices and a lack of credit is curtailing Brazil’s soaring farm sector.

In Asia, Pakistan, which reluctantly sought a $7.6 billion IMF loan, really needs $10 billion to $15 billion to prevent economic collapse, government officials say. Dubai’s pell-mell economic growth has been heavily financed by international debt that may be hard to refinance. South Korea, responding to shortages of foreign currency for her banks and businesses, in October announced a $100 billion government guarantee on foreign currency loans and a $30 billion infusion of dollars into her banks. More recently, that country has problems with high household debt, which leaped from 38% of GDP in 1997 to 66% last year and is probably higher today. And rising credit costs and falling stock and corporate bond prices are slashing the profits of Japanese banks and their ability to provide capital to the international financial system.

Central Bank Responses

Central banks have responded to the global financial crisis in three ways. First, the Fed cut the discount rate and then the federal funds rare repeatedly, starting in August 2007. The Fed has continued this traditional easing approach and other central banks have followed more recently and aggressively, including the European Central Bank, the Bank of England and the central banks of India, China, Australia, Norway, Sweden South Korea, the Czech Republic, Switzerland, Japan and even Indonesia.

Nevertheless, it became clear early on that rate cuts were of limited value since banks were so scared that they didn’t want to tend to each other much less customers. The spread between the London Interbank Lending rate on U.S. interbank loans and Treasury bills, which leaped in the summer of 2007, remains wide. Furthermore, central bank rates are approaching zero at which point, as we understand it, they’ll stop falling. So the ammunition of rate cuts is almost all shot off. The horse didn’t want to voluntarily walk to the water and, besides, the pond is almost empty. Fed Chairman Bernanke recently said, “The scope for using conventional interest rate policies to support the economy is obviously limited.”

So the Fed moved quickly to step 2, leading the horse to the water. It introduced a succession of facilities to auction money to member banks, make it available to nonbank government security dealers, etc. The ECB and the Bank of England introduced similar facilities. Last August, the People’s Bank of China, her central bank, relaxed credit quotas so most banks can lend 5% more this year and, more recently, allowed local companies to easily sell yuan-denominated debt of three-to-five years’ duration. Then China, it increased quotes for state-controlled lenders by $14.5 billion this year, encouraged local governments to support credit guarantee firms and opened new financing channels including loans for mergers and acquisitions and for consumer finance.

India’s central bank has repeatedly reduced bank reserve requirements as has China’s. And the Fed has attempted to satisfy foreign banks’ gigantic demand for Treasurys by mushrooming its currency swap agreements with foreign central banks and then providing unlimited dollars to the ECB, Bank of England and Swiss National Bank for lending to local banks. The top policymakers of the cautious ECB recently called for an “abundant and generalized” capital infusion into banks. But all these central bank efforts resulted in the proverbial pushing on a string. The funds have stayed in the banks and haven’t been lent out and entered the money supply to any meaningful degree as banks want nothing but Treasurys. The central banks led the commercial bank horse to water, but he wouldn’t drink.

So it’s on to step 3 with the Fed and other central banks, as well as governments, investing directly in Fannie and Freddie, AIG, banks, credit card issuers, insurers, etc. here and abroad, buying commercial paper and, most recently, purchasing indirectly credit card, auto, student and small business loan-backed securities and maybe extending later to commercial and residential mortgagebacked securities as well as subsidizing mortgage rates, as noted earlier.

Washington officials cringe at the suggestion that these measures amount to “quantitative easing,” the Japanese policy initiated in 2001, because it failed to rapidly spur Japanese bank lending and the economy and arrest deflation. The Bank of Japan drove its target rate to zero with no effect and then tried to hype the quantity of money by buying government bonds, asset-backed securities and even stocks.

Current quantitative easing by the Fed may not be any more successful than it was in Japan since the global financial system is in a classic liquidity trap, as in the 1930s when bankers were defined as people who wanted to lend to those who didn’t need to borrow and didn’t want to lend to those who did. Today, banks don’t want to lend to anyone but the U.S. Treasury.

Consumer Retrenchment

The financial crisis spawned by the collapse of the residential mortgage market and the follow-on Wall Street woes obviously just had to depress the goods and services economy, and it has in Phases 3 and 4 of the unfolding recession. With the collapse in stock prices and evaporation of home equity, consumers have no other meaningful source of borrowing to fund their spending growth in excess of their after-tax income gains. Notice that home equity withdrawals through cash-out mortgage refinancing and home equity loans reached about $900 billion at annual rates, or around 10% of consumer spending. Now it’s negative as principal repayment exceeds home equity withdrawals. So consumers’ 25-year borrowing and spending binge, as witnessed by their quarter-century saving rate decline (Chart 5) and borrowing rate surge (Chart 6), is over.

In addition, Americans, especially postwar babies, have saved little for retirement as they concentrated instead on spending. The nosedive in stocks has only made retirement prospects more bleak. In the last 15 months, $2 trillion has disappeared from workplace retirement accounts, including 401(k)s, which now are the primary saving vehicle for 60% of employees.

Jobs

As the housing and financial sectors continue to drop and U.S. consumers retrench, layoffs and unemployment will continue to mount. Payroll employment, which fell 533,000 in November (Chart 7), will probably continue to see monthly declines of 500,000 and the unemployment rate will likely exceed 8% by the end of 2009.

Housing and financial services job cuts are already large and more are coming. But job losses have spread well beyond housing and finance. Manufacturing jobs will continue to be lost as consumers buy fewer domestic goods and foreigners buy fewer American-made products. Retail jobs, normally the employment of last resort for the newly unemployed, are shrinking rapidly. Retail trade employs 10% of the total, but since November 2007, accounted for a quarter of jobs lost, or 320,000, as consumers cut their spending. And another 209,000 retail employees had their full-time hours cut to part-time. Estimates are that 6,100 U.S. stores — ranging from mom-and-pops to major chains — will fold this year, up 25% from 2007, and followed by 14,000 stores in 2009.

Impotent Monetary Policy

Conventional monetary policy ease through central bank target interest rate cuts at present is nearly useless, i.e., pushing on a string. Qualitative easing, now actively pursued by the Fed and the Treasury and by central banks and governments abroad, will probably at best only stabilize demoralized financial structures by substituting government securities for questionable assets with little near-term rejuvenation of lending and economic activity.

Also, bear in mind that in democracies, governments are almost guaranteed to be behind the curve in dealing with financial and economic crises. That’s because voters elect them to respond to their concerns, not to act in anticipation of yet-unseen problems. Politicians are responders, not planners. In 2006, neither voters nor politicians wanted to prepare for a mortgage market collapse, but voters demanded and got swift action after the crisis unfolded in 2007 and this year.

This means that any resuscitation of the global economies falls on fiscal policy and, as usual, the effects will be delayed, influencing the recovery after the recession rather than shortening its normal course. The incoming Obama Administration is, of course, talking about a sizable fiscal package, perhaps $500 billion to $700 billion, or 3.5% to 5% of GDP.

$700 Billion In Perspective

That’s a lot compared to the size of post- World War II recessions (Chart 8). Notice that the 1957-1958 recession, the most severe so far, has a peak to trough decline in real GDP of 3.7%, and the long and deep 1973-1975 downturn saw a 3.1% decline. We’re forecasting the most severe recession since the 1930s with a 5.0% decline. You may think that a 5% decline is not a lot, but bear in mind that recessions are more interruptions in growth than economic collapses — growth that business, consumers, employees and government assume will continue without interruption. Similarly, the 21% decline in the Case-Shiller house price index so far (Chart 2) is small compared with the more-than-doubling during the bubble years. Still, it’s very painful for those who made small downpayments at the top and those who extracted their equity when prices were still high.

Even a $700 billion fiscal package would probably have limited impact on the recession, and not start to be effective until the end of 2009. And even then, the effects will probably barely offset the negative cumulative recessionary forces. Obama says his proposal will create 2.5 million jobs over two years. But as discussed earlier, payroll declines are likely to continue to run 500,000 per month, so his program would only offset five months of recessionary losses.

Phase 4

Phase 4 of the recession, its globalization, is clearly underway with almost every major country’s economy falling whether or not the official recession label has yet been applied. One indicator of weakness is the 2.4% decline in global semiconductor sales in October after a 2.1% fall in September from a year earlier, reflecting softness in computer and cell phone sales. The worldwide turndown is driven by housing slumps, notably in Ireland, the U.K., Spain, Australia and China. U.S. financial woes have spread to almost all major financial institutions worldwide. And consumer spending has been weak in Europe and Japan. U.S. consumer spending accounts for 71% of GDP but less than 60% in all other G-7 countries except the U.K. Sure, much more of healthcare and education expenditures tend to come from government, not consumer pockets in those lands, but households have traditionally been more cautious spenders than Americans, especially in recent years.

And this introduces another key reason for global recession — retrenchment of U.S. consumers, which depresses U.S. imports on which the rest of the world depends for growth. The huge U.S. trade deficit is the counterpart of the rest of the world’s huge surplus.

Commodities

Obviously, the commodities boom is over. Prices of energy, base and precious metals and agricultural products are all down significantly from peak prices. The global recession has reversed the earlier excess of demand over supply.

Also, institutional and individual investors who earlier rushed into commodities under the belief that they are a legitimate asset class like stocks and bonds are stampeding out even faster. The financial crisis has also made investors wary of structured notes and other commodity-linked instruments — and of the firms espousing them.

Tsunami In The Swimming Pool

As noted at the outset, the first two phases of the recession were largely financial, the residential mortgage collapse and the following Wall Street woes. Then, like a tsunami in a swimming pool, that financial tidal wave rolled to the other side and inundated the goods and services economy, with Phase 3, consumer retrenchment, and Phase 4, global slump. Now the tsunami is being reflected back to the financial side of the pool in three ways.

First, retrenching consumers will keep pushing up delinquencies on credit cards, home equity, auto and student loan debt, which will result in big writedowns for their many institutional holders. Collectively, these four categories amount to $4.4 trillion, dwarfing the $0.7 trillion in subprime loans.

Commercial real estate debt is the second problem area, and of the $3.5 trillion outstanding, $800 billion is in commercial mortgage- backed securities and $2 trillion in commercial mortgages held in regional and community banks. As vacancies rise, big writedowns will follow.

Third is nonfinancial leveraged loans and junk binds. Delinquencies have barely risen from rock bottom levels, but will as anticipated by yield spreads and 20% junk bond yields. Recession-depressed revenues here and abroad, collapsing commodity prices and the leaping dollar that will turn earlier currency translation gains to losses, will all slaughter the corporate earnings of nonfinancial corporations, so far relatively untouched by the financial recession. So delinquencies and charge-offs of junk securities will leap and many investment-grade debts will be pushed into junk territory. Junk bond spreads vs. Treasurys now imply a 21% default rate, higher than in 1933 at the bottom of the Depression. Financial institutions also own a lot of the $3.7 trillion in leveraged loans and junk bonds.

If the tsunami moving from the goods and services side of the pool does considerably more damage to the financial side, it will again be reflected back and even tighter financing will devastate the real economy. Policymakers here and abroad, of course, are trying to erect baffles in the form of bailouts in the middle of the pool to dampen the waves. They are learning that they have to build those baffles bigger and stronger to prevent the waves washing over them. Their moves from Fed interest rate cuts to massive quantitative easing, described earlier, shows they’re making progress.

Recession Ends When?

If policymakers succeed in containing the mortgage mess and bailing out financial crises related to consumer borrowing, commercial real estate and junk securities — and other financial problems we haven’t explained in detail — then the recession may well end at the end of 2009 as massive fiscal stimulus begins to take hold. If not, it probably will extend well into 2010 and perhaps beyond.

To end the crisis, four developments are needed, in our view. The elimination of excess house inventories will probably continue until at least the end of 2010, as discussed earlier. The writedowns and recapitalizations of financial institutions — at least those related mainly to mortgage-related problems that have unfolded so far — are well along.

Subsidizing the mortgages of underwater homeowners is beginning to develop. And of course the quicker the excess house inventories are eliminated, the more limited will be further house price declines and the fewer will be the additional homeowners who will slip under water. Bailouts of bad loans and securities in the three additional areas we’ve identified are big unknowns in terms of cost and feasibility. Nevertheless, policymakers are gaining experience as they grope their way through the current round of bailouts and may be real pros when further big problems surface.

The Dollar

At the end of last year, we forecast that the dollar would end its seven-year slump and rally later in the year against most currencies, but not the yen. And it did, starting in July. It was obvious a year ago that far too many were negative on the greenback. As with commodities, many institutional and individual investors considered foreign currencies as an asset class, worthy of a certain percentage of their portfolio.

Much more importantly, we were forecasting a major global recession and reasoned that, as usual in times of trouble, the dollar would be the global safe haven. We didn’t expect the U.S. economy to improve but that the rest of the world would join America in the tank. The greenback would be the best of a universally bad lot. We expect the dollar to keep rising for the next 5 to 7 years, continuing the long- run pattern.

Profits

With the nonfinancial sector joining financial businesses in full retreat, domestic corporate earnings will be decimated in coming quarters, as discussed earlier. And U.S.-based multinationals will also be clobbered by weak foreign revenues and the strong dollar, which will make foreign earnings worth less in dollar terms. Some 30% to 50% of revenues of consumer staple companies like PepsiCo, Sara Lee and Campbell Soup come from abroad. With our forecast of a severe recession, we look for corporate profits, as defined by the Commerce Department, to fall 48% from their peak in the third quarter 2007 to the fourth quarter 2009, and to drop 32% from 2008 to 2009.

P/Es and Stock Prices

Our forecasts imply S&P 500 operating earnings of $40 per share in 2009, down 35% from our $62 estimate for this year. That may sound extreme, but not for the most severe worldwide financial crisis and deepest global recession since the 1930s. At stock market bottoms, the S&P 500 P/E tends to be in the 10-12 range. But low interest rates normally push up P/Es and 10-year Treasury now yield 2.66%, and will probably be even lower later while 30-year Treasury bonds are now at 3.0%, our long-held target, and also a low in recent decades, but may drop further.

So a P/E of 15 at the stock bottom sounds reasonable, but would put the S&P 500 index at 600 then, down 32% from here and 61% below its record close on Oct. 9, 2007. Wow! Earlier, we warned of the number 777, not the Boeing airliner model but the low on the S&P 500 in 2002. If it were breached, we noted, then the bear market that started in early 2000 would still be intact, and all of the rally from the 777 low in October 2002 to the peak five years later would merely be a rally in a bear market. Last month, the S&P 500 fell below 777. It has since bounced, but probably not for long as new lows lie ahead.

There are other reasons to expect considerable further weakness in stocks. High dividends can support stocks at least to a degree, and dividend yields in Europe are meaningful, averaging 5.2%. But not in the U.S. where the S&P 500 yield is a miserly 2.5%. And dividend cuts are coming fast and furious. In the U.K., dividends are constrained for financial institutions getting government bailouts, while in the U.S., the financial sector is slashing dividends.

Some 36 of the S&P 500 have cut dividends 46 times this year, axing $33.8 billion, with $30.8 billion coming from financials. Among those S&P 500 firms, about 20% of dividends this year are from financials, down from 34% in 2007. Elsewhere, REITs are cutting payouts, and GM eliminated its dividend. Only 202 S&P 500 companies have initiated or raised dividends 218 times this year, representing payments of $18 billion, with only $2.4 billion being from financials. In 2007, 298 did so and only 12 reduced or suspended dividend payments.

In troubled times, investors tend to withdraw from foreign markets to concentrate on the home scene they know best. That’s why bear markets tend to be uniform. U.S. investors sold a net $92 billion in foreign stocks and bonds in the July-September period, a record flight from overseas investments, while foreign investors pulled over $100 billion from stocks in Japan, South Korea and India so far this year. U.S. stocks are actually falling less than most foreign markets.

Deflation

For years, we’ve been forecasting that chronic deflation of 1% to 2% per year would start with the next major global recession. Well, it’s here! In October, the U.S. producer price index fell 2.8% from September and the CPI dropped 1.0%, the biggest decline since before World War II. Sure, the big driver was the decline in energy costs, but even excluding food and energy, consumer prices dropped 0.1%.

The Fed worries that in deflation, offsetting monetary policy is difficult since its target rate has to stop declining when it reaches zero. Of course, the Fed has other tools as witnessed by the quantitative easing discussed earlier. Nevertheless, all these measures amount to leading the horse to water, as discussed earlier, and he may not drink. The deflation in Japan in the 1999-2005 years worried the Fed when it appeared imminent in the U.S. early in this decade, and it still does. Japan again faces chronic deflation, and the Bank of Japan forecast zero change in the CPI (ex food but not energy) for the fiscal year ending March 2010. Fed Vice Chairman Kohn said the lesson from Japan was that “we should be very aggressive in combating deflation.”

Deflation encourages saving since money is worth more later. It also spawns deflationary expectations. Buyers anticipate lower prices later by waiting to buy. That sires excess inventories and capacity, which forces prices down. Buyer suspicions are confirmed so they wait even further to buy, generating a self-feeding downward price spiral, as now seen in autos and houses. Deflation also elevates the cost of debts and debt service since both remain fixed in nominal terms but the revenues and incomes used to repay them tend to fall with overall prices.

Deflation fears and other forces have also reduced reducing 30-year Treasury bond yields to our long-held target of 3.0% and completed what we dubbed in 1981, when the yield was 14.7%, “the bond rally of a lifetime.” The recent financial crisis has also helped as investors abandon everything else — stocks and fixed income alike — in favor of Treasurys.

Deflation results from overall supply exceeding general demand. We have been forecasting the good deflation of excess supply, as in the late 1800s and in the 1920s, due to today’s confluence of semiconductors, the Internet, computers, biotech, telecom and other productivity-soaked technologies. But we have allowed for the bad deflation of deficient demand, as in the 1930s, if one of two adverse conditions develop — widespread financial crises and worldwide protectionism. Sadly, both are real possibilities.

Inflation?

Many, of course, worry not about deflation but inflation due to all the money being pumped out by central banks and governments globally. They no doubt are biased since most have lived only in an era of inflation and don’t agree with us that inflation is the result of excess government spending in wars, both hot and cold. In peacetime, deflation reigns. Starting with rearmament in the late 1930s, then World War II and the Cold War with its hot phases, Korea and Vietnam, wartime and inflation persisted for 60 years.

For now at least, all that money from central banks and governments isn’t getting outside financial institutions. We’re in a liquidity trap. The horse isn’t drinking, thank you very much. And if lenders do start to lend, central bankers, with their congenital fear of inflation, will no doubt reel in all that extra credit.

Even if the bank reserves stimulate the money supply with the usual multiplier effect, the credit created will pale in comparison to the destruction of derivatives and other privately-created liquidity due to persistent deleveraging and writedowns.

Finally, the consumer saving spree we’re forecasting will probably increase the saving rate by one percentage point per year on average for the next decade. That would generate a cumulative $5.5 trillion and go a long way to offsetting the intervening fiscal stimuli, and then some.

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Madoff Trading Statement, November 2008

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Pants, Box, Bill. Bill

– This is FUNNY!!!

– This too…

– A classic

– Santa


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There are some classic lines in retrospect in this one…

MarHedge 2001-Madoff

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from Jan. 2008

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Good stuff..

The scholar, trader, and author Nassim Nicholas Taleb brings a decidedly contrarian view to the world of finance, statistics, and risk. In 2007, he published The Black Swan: The Impact of the Highly Improbable, which argues that we should never ignore the possibility or importance of rare, unpredictable events. In this interview with the Quarterly, he looks at the current financial crisis through the lens of his Black Swan thinking.

The Quarterly: For people who haven’t read The Black Swan, can you quickly summarize what they should know to understand your point of view on recent events in global financial markets?

Nassim Nicholas Taleb: Before Europeans discovered Australia, we had no reason to believe that swans could be any other color but white. But they discovered Australia, saw black swans, and revised their beliefs. My idea in The Black Swan is to make people think of the unknown and of the potency of the unknown, particularly a certain class of events that you can’t imagine but can cost you a lot: rare but high-impact events.

So my black swan doesn’t have feathers. My black swan is an event with three properties. Number one, its probability is low and based on past knowledge. Two, although its probability is low, when it happens it has a massive impact. And three, people don’t see it coming before the fact, but after the fact, everybody saw it coming. So it’s prospectively unpredictable but retrospectively predictable.

Now that we’re in this financial crisis, for example, everybody saw it coming. But did they own bank stocks? Yes, they did. In other words, they say that they saw it coming because they had some thoughts in the shower about this possibility—not because they truly took measures to protect themselves from it.

Now, a black swan can be a negative event like a banking crisis. It also can be positive: inventing new technology, making new discoveries, meeting your mate, writing a best seller, or developing a cure for cancer, baldness, or bad breath. In The Black Swan, I say that in the historical and socioeconomic domain, black swans are everything. If you ignore black swans, you’ve got nothing. And I showed that the computer, the Internet, and the laser—three recent technological black swans—came out of nowhere. We didn’t know what they were, and when we had them right before our eyes we didn’t know what to do with them. The Internet was not built as something to help people communicate in chat rooms; it was a military application and it evolved.

So these things have a life of their own. You cannot predict a black swan. We also have some psychological blindness to black swans. We don’t understand them, because, genetically, we did not evolve in an environment where there were a lot of black swans. It’s not part of our intuition.

The Quarterly: Say a little more about the relationship between black swans and the global financial crisis.

Nassim Nicholas Taleb: I warned in The Black Swan against some classes of risk people don’t understand and against the tools used by risk managers—tools that could not fully capture the properties of the world in which we live. The financial crisis took place because people took a lot of hidden risks, which meant that a small blip could have massive consequences.

In fact, I tried in The Black Swan to turn a lot of black swans white! That’s why I kept going on and on against financial theories, financial-risk managers, and people who do quantitative finance. I warned that they were dangerous to society.

The Quarterly: You question many of the underpinnings of modern financial theory. If you were the dean of a business school, how would you overhaul the curriculum?

Nassim Nicholas Taleb: I would tell people to learn more accounting, more computer science, more business history, more financial history. And I would ban portfolio theory immediately. It’s what caused the problems. Frankly, anything in finance that has equations is suspicious. I would also ban the use of statistics because unless you know statistics very, very well, it’s a dangerous, double-edged sword. And I would ban linear regression. All these things don’t work.

The Quarterly: What are your concerns with statistics and portfolio theory?

Nassim Nicholas Taleb: The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world.

All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that. In the 1920s, the German mark went from three marks to a dollar to three trillion to a dollar in no time.

That’s why portfolio theory simply doesn’t work. It uses metrics like variance to describe risk, while most real risk comes from a single observation, so variance is a volatility that doesn’t really describe the risk. It’s very foolish to use variance.

The Quarterly: Does your thinking inform the debate over the efficient market hypothesis?

Nassim Nicholas Taleb: I have no idea. I don’t know if markets are efficient or inefficient. I don’t know if we’ll ever know. And I don’t know if it’s relevant.

The Quarterly: What does all this mean for managers at nonfinancial companies? What should they be doing differently?

Nassim Nicholas Taleb: I recommend two things. Number one, take the maximum amount of risk and other forms of exposure to positive black swans when this costs you very little if you’re wrong and earns you a lot if you’re right. Number two, minimize your exposure to negative black swans.
This is exactly the opposite of what the banks did. They had no real upside and a lot of downside—or, to be more precise, they got a little bit of cash flow to have all the downside. I recommend the opposite. Be hyperconservative when it comes to downside risk, hyperaggressive when it comes to opportunities that cost you very little. Most people have the wrong instinct. They do the opposite.

The Quarterly: What would your ideas look like in practice for, say, a manufacturer?

Nassim Nicholas Taleb: If risk doesn’t cost you a lot, take all the risk you can. That’s how economic growth is generated. Don’t fear being aggressive if that only costs you a little. Do more trial and error. Learn to fail with pride, comfort, and pleasure.

But try to have less downside exposure by building more slack into your system through redundancy, more insurance, more cash, and less leverage. Imagine a shock. What will happen if there’s a shock? How many months could you keep operating?

The problem is, Wall Street penalizes companies that have more of this kind of insurance, because they are going to lag behind companies that don’t take on the expense. I see this in my investment business. But you know what? The people who insured against catastrophes are still standing today. The other people are bust. So don’t fear overinsurance for your downside, even if you lag behind as a result.

The Quarterly: You’re a critic of scenario planning. Is there a way to do it effectively?

Nassim Nicholas Taleb: I don’t like scenario planning, because people don’t think out of the box. So scenario planning may focus on four, five, or six scenarios that you can envision, at the expense of others you can’t. Instead of looking at scenarios and forecasts, you should be looking to see how fragile your portfolio is. How vulnerable are you to model error? How vulnerable is your cash flow to changes in any parameter of your calculations? My idea is to base your navigation on fragility.

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Should help……

The Federal Reserve Board on Thursday approved final rules that would better protect credit card users by prohibiting certain unfair acts or practices and improving the disclosures consumers receive in connection with credit card accounts and other revolving credit plans.

The final rules prohibiting certain credit card practices were adopted under the Federal Trade Commission Act, and are being issued concurrently with substantially similar final rules by the Office of Thrift Supervision and the National Credit Union Administration. Among other things, the rules will:

Protect consumers from unexpected interest charges, including increases in the rate during the first year after account opening and increases in the rate charged on pre-existing credit card balances.
Forbid banks from imposing interest charges using the “two-cycle” billing method.
Require that consumers receive a reasonable amount of time to make their credit card payments.
Prohibit the use of payment allocation methods that unfairly maximize interest charges.
Address subprime credit cards by limiting the fees that reduce the amount of available credit.
In finalizing the rules on unfair credit card practices, the Board carefully considered information obtained through consumer testing and more than 60,000 comment letters received during the comment period.

“The revised rules represent the most comprehensive and sweeping reforms ever adopted by the Board for credit card accounts,” said Federal Reserve Chairman Ben S. Bernanke. “These protections will allow consumers to access credit on terms that are fair and more easily understood.”

The Board is also adopting final rules to revise the disclosures consumers receive in connection with credit card accounts and other revolving credit plans to ensure that information is provided in a timely manner and in a form that is readily understandable. These rules amend Regulation Z (Truth in Lending) and conclude a comprehensive review of the open-end credit rules. The final rules under Regulation Z require changes to the format, timing, and content requirements for credit card applications and solicitations and for the disclosures that consumers receive throughout the life of an open-end account. Many of the changes reflect the result of consumer testing conducted on behalf of the Board during its review.

“Our intent is to increase transparency and fairness in how credit card and deposit accounts operate, thereby enhancing competition and empowering consumers to better manage their accounts and avoid unnecessary costs,” said Federal Reserve Governor Randall S. Kroszner. “The rules represent a significant step forward in consumer protection. By ensuring fairness and making credit terms easier to understand, these safeguards should allow more consumers to benefit from using credit.”

Both of the final rules addressing credit card accounts take effect on July 1, 2010.

The Board is separately proposing rules to protect consumers that use overdraft services offered by their bank. The rule solicits public comment on proposed amendments to Regulation E (Electronic Fund Transfers) intended to provide consumers a choice regarding their institution’s payment of overdrafts for automated teller machine withdrawals and one-time debit card transactions. The Board is proposing two alternative approaches to providing consumer choice, including a proposed requirement that would require institutions to obtain consumers’ affirmative consent (or opt-in) before any overdraft fees or charges may be imposed on consumers’ accounts. The comment period for the Regulation E proposal ends 60 days after publication in the Federal Register.

In a related move, the Board is adopting final amendments to Regulation DD (Truth in Savings) to address depository institutions’ disclosure practices related to overd

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So, took the plung again today.

With OPEC cutting production (yeah, I know, they cheat on the cuts, but there will be cuts) and more importantly, US projects are  being put on hold.  Crude oil under $40 just is not right based on the fundamentals.

Here are some recent thoughts on it from early December.

Not long after that, 60 minutes did this piece on Oil

Watch CBS Videos Online

Here is the thing. Watch this 2005 CNBC oil special. Note the Saudi’s are today saying what they said then, yet supply, has not significantly increased since then.

Finally a week after I began going down this road again, I read this

Today crude dipped below $40 a barrel and I decided it was time. I did a combination of the PowerShares DB Oil Fund (ETF) (NYSE:DBO) and PowerShares DB Crude Oil Double Long ETN (NYSE:DXO).

From Jan 2007 to April 2008 we rode USO from $47 to $106. I’m expecting similar results this time and by using more efficient ETF’s ought to get better results (neither the DBO, nor DXO existed in Jan. 2007).

The wild card here is the dollar. It is far weaker now than it was in Jan. 2007 and even in April 2008. One also has to consider the Fed and Treasury are running the printing presses flat out for the dollar and that is flooding supply. Further deterioration of the dollar (it is going to happen) will add upward price pressure to oil that has nothing to do with supply /demand.

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Check this out…was just emailed to me..

This is stunning… it lays out what just happened…

Page Two: “Madoff securities is the world’s largest Ponzi scheme…”

WOW..

November 2005 Report to SEC about Madoff Being A Poniz Scheme

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Global warming, Cheap oil, Zero, 5.4%

– The Myth

– Not for long

– Could we really hit it?

– Great yield

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This is fantastic stuff. Just got off the SEC Conference call.

So, the SEC is going to require companies to begin reporting results in interactive data. So what you say? Look what it enables us to do. Go to http://viewerprototype1.com/viewer and select those companies who are voluntarily participating.

From there you can download the statements you wish to an xls file (Excel) and for those on Google Docs, you can upload the file to Good spreadsheet and then embed it into a blog post like below.

Here is GE’s (GE) recent 8-K income statement

This is not even to mention that you can easily now save it for easy access on your computer.

There are dozen of other uses for folks far more tech savvy than me but in my corner of the world this is really great stuff..

Disclosure (“none” means no position):Long GE
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