Defiance at the Fed

Defiance at the Fed

James Dunigan of PNC Wealth Management sums up market sentiment for the week:

“The recovery is in place and by all evidence looks to be sustainable and at the end of the rainbow, that all filters down to corporate profits.”

Perhaps the St. Patrick’s Day theme got out of hand for James. There is seldom much to be found at the end of a rainbow – not even leprechauns. Apart from that, rainbows aren’t sustainable either. But it’s the “all evidence” bit that is ridiculous. He sounds like a global warming disciple. More on that later.

Any real recovery would be accompanied by interest rate increases from the Federal Reserve. Instead, the Fed stuck to its guns and butter interest rate. Dan Denning is another step closer to his free beer bet coming off. He even doubts that the Fed will go through with its withdrawal of support from the U.S. mortgage market.

Instead of a recovery, at this point, all evidence points to an economy on life support. The drugs are keeping the patient alive, but each day they cause more damage. That’s why the decision to keep rates flat wasn’t quite smooth sailing for the chief moneyprinter – Ben Bernanke.

But what does the FOMC’s sole defiant dissenter say to justify his position? Thomas Hoenig of the Kansas City Fed, and the oldest serving policy maker, inadvertently represented the Austrian School of Economics when he wrote:

“… continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the build-up of financial imbalances and increase risks to longer-run macroeconomic and financial stability,…”

The lack of reference to inflation is concerning. After all, isn’t that what the central banks are supposed to focus on?

Dan Denning has been hammering out his argument for inflation during the week. This is in the face of deflationist forecasts from those who share his negative outlook. At the heart of his argument is the ability of the government to defeat the deflationary cycle with increasingly absurd ideas – like handing out free money. Who would do something like that, Kevin?

Fed representative Thomas Hoenig also commented on proposed financial regulation in a letter sent to U.S. Senators:

“It is a striking irony to me that the outcome of the public anger directed toward Washington and Wall Street may lead to further empowerment of both Washington and Wall Street in regulating financial institutions.”

Hoenig must be unaware that the author of the proposed regulation is Chris Dodd. This clever politician funded his 2008 presidential campaign in a surprising way. Seven out of his top ten donors were banks that received bailout money in the same year.

How the political system’s funding works:

Taxpayer –» Government –» Wallstreet –» Politicians –» Wallstreet –» Politicians ….

Derivatives Uncovered

Derivatives have come under fire from governments globally. One valuable thing they have done is to expand the financial vocabulary. Trillion is no longer the punch-word it used to be. The Bank of International Settlements brought “Quadrillion” into play. Global derivatives outstanding are now measured in Quadrillions.

Hmm. So if global GDP measures as a fraction of derivatives outstanding, one wonders who actually holds sway in the world. Is it the businessmen and politicians, whose careers are entwined in GDP numbers? Nope, probably not.

Making matters more suspicious is the lack of transparency in some derivative markets. How can something so huge be kept so secretive?

Case in point is the Credit Default Swap (CDS) market. A CDS allows a person to pay another person in exchange for bearing the risk of default – like insurance. According to Dan Ferris in the S&A Digest, which is published by Stansberry & Associates Research, the CDS market is so secretive because it was made to be that way. Can you guess by whom? The government of course.

The Commodity Futures Modernization Act ensured that CDSs were regulated underground instead of by a transparent public futures market, which was being designed before the law put an end to it. A transparent CDS futures market would have caused quite a stir in financial markets.

“Everybody and his brother would have seen prices on CDSs for Lehman Brothers and AIG rising during the summer of 2008, harbingers of impending doom, way ahead of the ratings agencies.”

CDSs are warning of trouble with the PIGS’ bonds now. An ominous sign?

It might explain why governments are being so aggressive towards CDSs in particular.

Hey, politicians are even pulling the sympathy card now:

The matter is “not only an economic problem, but an ethical one” said the Greek Prime Minister, referring to the cost of borrowing he faces. If the CDS markets signal further problems, those borrowing costs will increase.

Doubters of the claim that government regulators would cover up derivative markets from prying eyes of the public, consider their other feat of genius:

“What’s more, banks sold prime mortgage loans and bought “triple-A-rated” collateralized debt obligations (CDOs) only because the Basel II Capital Accords established lower capital requirements for triple-A-rated securities than for prime mortgage loans.”

So, not only did regulators set up the institutions which securitised CDOs, they also told banks they were safer than good loans. Someone had to be forced buy them. No wonder banks struggled during housing collapse.

Road to Nowhere

Countries seem to be racing each other to a debt crisis. That’s why the be-ratings agencies are watching them closely. Occasionally, like a younger sibling, the debt scrutinisers make an irritating remark, before withdrawing into smug state of expressing phony concern about the situation.

Standard and Poor ‘s (could a debt rating agency be named more appropriately?) has warned that the Greek crisis will come to a head next year.

“Three sets of austerity measures this year will lead to an economic contraction of 4 percent in 2010, making it more difficult for the government to raise revenue and carry out the deficit reductions pledged for next year.”

Wow, a 4% contraction.

Credit Agricole analyst Peter Charwell seems to think this is wonderful.

“You’re starting to see some tangible benefits of the austerity measures Greece has put in place.”

Although teargas isn’t technically tangible, stun grenades and rocks are. All of them are beneficial to the person using them, but not so beneficial otherwise.

Germany’s about face on the EU bailout plan has got the Greek government in a pickle. Like any cornered government, it is resorting to threats…

“Greek Prime Minister George Papandreou,” who was elected for his promises to spend more, “set a one-week deadline for the European Union to craft a financial aid mechanism for Greece, challenging Germany to give up its doubts about a rescue package.”

That’s right. They are bullying the Germans into giving them money. Historically speaking, that works best after a world war and leads to another one.

But guess where Greece buys much of its military from?


By the way, according to some reader feedback, using the PIGS acronym is racist. Particularly as it includes the proud people of Spain, who would never default, out of a matter of honour, according to one reader. Furthermore – this reader continues – your editor has apparently never been to Spain does thus not know anything about it.

Ay caramba!

The equally racist and untravelled Bloomberg has picked up on the tendency of the Spanish government to simply not complete parts of the budget, and then claim savings equal to the parts left out. They literally left sections blank. Unfortunately, people noticed.

Lombard Street Research points out that, “loan loss recognition, notably in Spain, remains troublingly slow.”

Perhaps they should get Juan Carlos Granda (also known as Robin Hood) on the case. He specialises in public shaming to enhance debt collection activities. According to Granda, and your editor’s Spanish family members, it is about the only way debt collection is likely to happen in a reasonable time frame in Spain.

“The government and justice system don’t do anything … and people think they can get away with anything. We are here to do public justice,” says Granda.

Very honourable.

But it wouldn’t be fair to say that only the Spanish are a bit slow with their loan loss recognition. NAB declared “that its $18.4 billion portfolio of troubled credit instruments had caused losses of $1.3 billion over the past two years… It was NAB’s first disclosure of the damage done by the holdings.”

Dan looked into the implications on Wednesday.

Governments do it with Interest

Meanwhile, Bloomberg reports that “the U.S. will spend more on debt service as a percentage of [government] revenue this year than any other top-rated country except the U.K.”

When interest becomes unaffordable, you’ve got a problem. Unless you can print the world’s reserve currency – then everybody has got a problem.

U.S. President Barack Obama isn’t just neglecting Australia because of his healthcare crusade. His home state of Illinois has a $13 billion dollar shortfall in their $28 billion dollar budget. Libraries are closing down, 20% of busses have ceased running, teachers are preparing for mass layoffs and cop cars have been repossessed! Prisons have stopped taking inmates out of protest that the vouchers, on which the state government has been running since October, are completely unfunded.

It’s a good time to be a criminal in Illinois!

Super Special

Super seems to be dominating the agenda … again. Even morning television can’t leave it alone. TV host Koshie suggested having a “Sunrise Super Special”, much to the distress of his co-host. That was after a viewer sent in an email asking Koshie to “tell it like it is”.

The email, which was read out by the co-host, went something like this:

“If you have $100,000 in your super and you lose 50%, you are down to $50,000. A subsequent 62% improvement will leave you $19,000 short of your original amount.”

That analysis is a bid dodgy, but Koshie’s stuttered reply was the real farce:

“But it’s still gone up.”

No, it hasn’t…

The proportions at work in percentage changes are blatantly obvious, but often misunderstood. It looks like Koshie was in the “misunderstood” camp.

Basically, a fall of 50% requires a 100% gain to return to previous levels. Likewise, a rally of 50% only needs a 33% drop to be wiped out.

Favourable odds?

Anyway, back to Super.

Past Markets and Moneys referenced the OECD report which led to the Sydney Morning Herald’s article “Australian Super Worst in OECD”. With a “$700 bn Shortfall in Super looming,” it hardly seems fair to beat Super while it’s down.

But the cat is out of the bag.

The Australian newspaper has been looking at a Coredata polling effort, which drew the following conclusions:

“Almost two-thirds of Australians support an increase in compulsory superannuation contributions to 12 per cent, …”

That’s odd. People want to give away their money to a government scheme, which ranks last, and has a shortfall which amounts to New Zealand’s GDP seven times over.

Are Australian’s that dumb? No, obviously not, as the article explains:

“But the same survey … showed only 34.4 per cent of members were satisfied with the investment performance of their super fund.”

So, only a third of those polled are dumb. Two thirds (including the dumb one) are gullible.

Where do the politicians sit in this division? The Australian correspondent, Jennifer Hewett (not the Love one), reckons they aren’t bothered much at all. Even if your title is “Superannuation Minister”, you can relax.

“There is no sign [Superannuation Minister Chris Bowen] believes raising the current compulsory 9 per cent figure is a matter of urgency.”

$700 billion? No worries!

Going Green

Another spin-off from the global warming hype has been identified by the UK Guardian.

Apparently, being a global warming disciple does not make you a bad person – unless you act on it. Canadian psychologists Nina Mazar and Chen-Bo Zhong have published a study claiming those wearing a “halo of green consumerism” are “less likely to be kind to others, and more likely to cheat and steal.”

As Al Gore supposedly uses green energy to provide his astronomical home energy needs, it would not be fair to say he is hypocritical on this count. But if the study is right, does that mean his more likely to cheat and steal in an unkind way than your run of the mill global warming denier? Hmmn.

Have a great weekend.

Nickolai Hubble.
Markets and Money Week in Review

Nick Hubble
Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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