Saturday, September 03, 2011

Undeniable Truths of Money #3: The Herd Is Always Wrong At Inflection Points

Q:  What significance does October 10, 2007 have to investing?

A - It was the all-time high in the stock market
B - It was the most bullish day in the history of the stock market
C - It was the best day to sell in the history of the stock market
D - It was the worst day to buy in the history of the stock market
E - All of the above.

For those who still believe the stock market is a discounting mechanism and a predictor of the economy 9 months in advance, you need to dig the gravel out of your cranium.  The summer of 2008 was a train wreck in the US economy, but if you went by the stock market "forward looking mechanism," there should have been money raining down from Heaven. 

Why?  What happened?

The greatest fool (peak idiot) in US stocks was found.  He is the one that bought on 10/10/07, and he wasn't alone.  The pack was more invested on that day than at any other time in our history.  Bulls were running hard and it looked like nobody would ever stop them.  They had climbed that wall of fear coming out of the blowup in the Bear Stearns hedge funds to their high water mark, and it was all downhill after that.

In reality, the minority (contrarians) were correct on that day.  The bears were the real winners on 10/10/07.

How can this be?  CNBC tells us that bullish sentiment is a good indicator of future performance, but is it?  We say no.

10/10/07 was an inflection point.  We only know that in hindsight, because nobody rings the bell at the top.  All the buyers were in.  If you weren't in by that point in time, you didn't want to be in.  All the buyers were in and the only thing left to do was sell.  They had to sell into a growing crowd of sellers.

This also works at bottoms.  03/09/09 was a bottom.  Fear was never higher than that day when the S&P hit 666, when all the sellers had punched out.  The only thing left to do was buy.

The trend my be your friend, but not for long.  The trend only works between inflection points, and the longer it takes you to recognize the trend, the shorter the friendship will be.  If the trend is very popular, it has almost run its course and Mr. Market will do what he does best and screw the most people out of as much money as he can.  The contrarians are the ones that clean up, but even contrarians need to exercise caution.  It isn't enough to simply be "contrarian."  All that does is make you insufferable at parties (ask me how I know this).  Contrarians need to keep quiet during the periods where trends rule, which are typically midway between inflection points.  They need to watch for trends losing steam on the way up, or diving into a panic on the way down, as those are the indicators that too many people are on the same side (which will ultimately be the wrong side) of the trade.

When the boat gets overloaded, it doesn't take much to tip it over.

Bainbridgeislanddreamhomes peaked in October of 2008.  California equity money dried up about a year earlier.  The peak money was in and now the escalator stopped.  The pressure to move the market upward died, so the only thing left to do was sell into a declining pool of buyers.  The worst time to buy a Bainbridgeislanddreamhome  was when the market was at its most enthusiastic.  The sellers were the ones with fortune and glory on their side.

That's why this is not the best time to buy a home.  The best time to buy will be when all of today's conventional wisdom is shattered.  Interest rates will have to be peaking, not troughing.  Unemployment will have to be peaking.  Rather than hearing "BUY NOW OR BE PRICED OUT FOREVER," you will be hearing "WHY WOULD YOU EVER BUY A BAINBRIDGEISLANDDREAMHOME, SINCE THE VALUE ALWAYS GOES DOWN?"  Down payments will be high, not low.  Nobody will think of housing as an investment - it will simply be an expensive, money pit that is a necessary evil of life.

The herd and conventional wisdom will be wrong then, as well.

Thursday, August 18, 2011

Undeniable Truths of Money #2: For You To Get Out Of A Trade, Someone Else Must Get Into The Trade

That's why they call it a "trade."

When you find yourself on the losing end of a "sure thing" trade, the one thing you want more than anything else is to find someone to dump it to - at full price.  The problem is if you know it, everyone else does as well.  In order for your problem not to be your problem, it must become someone else's problem.

This is why we have marketing departments.  We need to put lipstick on our pigs and sell them off to others.

This is the problem faced by our banking industry.  They are massively offsides with regard to the assets they are holding.  If they were fairly valued, they would all be sold at auction, and the banks would be dead.  The government is allowing them to carry their assets at whatever fantasy valuation they want in order to prevent this.  Part two of their strategy is to convince someone to take their bad assets - at full price. 

In order for them to get out of their trade, someone else must get into their trade.

This is why they are trying to convince you to get out of your "worthless" dollars.  These dollars are so worthless and hopeless, the banks are willing to do anything to relieve you of them, because when you think of "Good Samaritan," your mind immediately springs to bankers.  They want to take your dollars and give you assets in return (the assets that dropped in value so much that it caused the 2008 financial meltdown) so as to spare you the horror of watching your savings destroyed by "inflation."

It wouldn't be much of a marketing success if the banks came to you and said, "Look, you have cash and we have these assets that are almost worthless.  We were allowed to lie about their valuation, and we have been holding yields down with all the prestidigitation at the Federal Reserve so as to run down the value of the dollars you are holding, so how about giving us dollars as they are approaching their bottom in exchange for these overinflated assets that are killing us?"

No, that wouldn't work.  They need a better strategy - something like, "Look at how these assets we are holding have held their values while your dollars are going worthless.  You need to get into assets and out of dollars to save your livelihoods.  We are Wall Street banks and we know what is best for everyone.  Buy our assets, or we will go to the Treasury and force you to buy them through the government."

They want out of their assets and they want your cash.  They need you (either voluntarily or through the government) to take them out of a trade that is killing them.

Monday, August 15, 2011

Undeniable Truths of Money #1: Debt is the Antithesis of Wealth

Own yourself.

By borrowing money, you go into debt and as such you are pledging your future productivity to extinguishing that debt.  This debt almost always carries interest, which is an additional claim against your productivity.  As long as you owe your lenders, you are not free to put your excess productivity to the endeavors of your choosing - you owe it to someone else.

Let's presume Jennifer Munn and Jason Dane are the proud owners of the Widgetmaster 4000, which produces $5000 of highly marketable widgets per month.  They own this glorious machine free-and-clear.  It's all theirs and everything that comes out of it is all theirs to sell.

That's wealth - the ability to produce income.

Life is good.  The Munn-Danes sit back and watch their Widgetmaster 4000 pump out $5000 worth of widgets per month.  The UPS man comes and picks up the widgets, carries them to the four corners of the earth, and their Paypal account grows and grows.  They buy the groceries, pay the bills and live a good life in their mortgage-free three bedroom rambler and fully paid F-150.

They get some new neighbors from West Seattle, Joe Hippen and Mary Trendy, who are really living large in their contemporary Northwestern Bainbridgeislanddreamhome on Rolling Bay.  They have annual trips to Paris and London, Sounders FC season tickets, and constant dinner parties entertaining the parade of drug addicts disguised as friends they met at the latest Burning Man extravaganza.  Swathmore and Marist brag stickers adorn the rear windows of their His/Hers Escalades as they drive off to their jobs as government equal opportunity lawyers.

It would appear that the Hippen-Trendys are very wealthy.  Why not?  They are certainly flaunting their "wealth," and their jobs as lawyers for Uncle Sugar probably pay pretty well - $200,000 per year, which certainly dwarfs the owner/operator of the Widgetmaster 4000's $60,000 per year.

It turns out that many people have a claim to a chunk of the Hippen-Trendy's income.  The mortgage on that $1.1 million home runs $64,500, the leases on the Escalades run $24,000, college debt runs $48,000, and their ancillary spending is financed by signature loans and credit cards that run $17,000 for a 10 year payment plan, but they only pay half that.  That $200 grand gets cut down to $55,000, and that is before the IRS gets their cut.

The Hippen-Trendys have only one "asset" as we would define it, and that is the sheepskin that enabled them to get civil service lawyer jobs, for which they give back almost 1/4 of the dividend.  The house is underwater, the Escalades are zeroes, and the revolving credit has nothing they can use to sell off - it was all consumed.

The Munn-Danes have a higher net income than the Hippen-Trendys because they own themselves.  The Hippen-Trendys have to work until early October before they have paid off the bankers, which is another way of saying the bankers own their entire production from January through Columbus Day.  The Munn-Danes own themselves before the New Years Eve hangover wears off (IRS issues not withstanding).

We can also see how this works with net savings and debt.  All of us can agree that a cash account of $500,000 would be an asset and would qualify its owner as wealthy.  Let's presume this account is invested in various bonds that pay 6% interest.  The income stream is $30,000 per year.  On the other side of the ledger, the borrower (Ace Novelty Company of Walla Walla) is carrying a $500,000 debt which is costing them $30,000 per year.  One is the antithesis of the other.  One has wealth, the other has debt.

In the case of Ace Novelty Company, they are using the $500,000 to build a rubber dog squeeze factory in Hong Kong, where they show they will be able to produce $50,000 worth of rubber dog squeeze per year, which is flown by cargo plane back to the United States.  After they pay back the $30,000 plus principal to the bond holder, they still end up with a profit, and after the debt is paid back, they will have an unencumbered asset and full claim to its production.

Debt isn't necessarily bad, it just precludes you from owning yourself.  If you don't own yourself, someone else does, and bad things descend from that reality.

Friday, May 06, 2011

Commodity Crack-up

I guess SEAL Team Six went directly from Bin Laden's hide-out to the commodity exchange and brought its signature lethality.

If you want to know what happens when the "shoeshine boy" is in the trade, look at these charts.

Silver, Nat Gas, Oil, Australian Dollar
If I had a dog as ugly as those charts, I'd shave its rear and walk it backwards.

This is what happens when AM radio (the modern 'shoeshine boy') confuses printing with borrowing and inflation with leverage and everyone is on the same side of the trade.  More selling is coming and volitility is going to be going up from here.


Tuesday, May 03, 2011

Peeking Around The Corner: Is The Dollar About To Rebound?

"Crush Depth" is the depth that a submarine can no longer resist the ambient pressure and will catastrophically fail...and die.  It is the point of no return.  All airplanes eventually land (in some form or fashion), but not all submarines surface.

The USS Dollar is approaching crush depth.  Skipper Bernanke has gone guano-insane and has finger-fouled the USS Dollar into into the abyss to avoid the depth charges of deflationary reality.  The crew is seems powerless to discontinue this suicide mission.

Perhaps a mutiny is in the works.  Someone is going to grab the "Emergency Blow" handle, but will it happen in time?

Today, ladies and gentlemen, we are going to chart up a storm and see if we can peek around the corner.

First off, the USS Dead Presidents (plus Ben Franklin and Hamilton).

Dollar Index

Well...filthy lucre is looking pretty filthy.  The Yankee Lira is getting pounded on a daily basis.  Every day we wake up and it is getting smaller and smaller.  That's pretty ugly and all the arm waivers on the lobotomy box and AM radio are assuring you this trend will continue indefinitely.  The dollar (according to the 'experts' is going the way of the Weimar Deutchmark.  In fact, the only thing that will be of value (other than the gold they are selling) will be the wheelbarrows we will need to buy our new iPads.  We will need to relearn scientific notation to pay our NETFLIX subscriptions while we wolf down our CHIPOTLE burritos.

As anyone who knows anything about anything knows, all trends are permanent and you should buy now, or be priced out forever.  After all, that house you bought in 2007 should be worth another 50% by now (assuming 10-12% appreciation).

The theory goes something like this:  Bernanke is "printing" money to pay the national debt that is essential for us to stave off negative GDP growth.  We are therefore subject to the dollar getting smaller and that means we will pay more for "stuff" while our bosses don't have to pay more for our labor.  "Stagflation" is the term the "experts" like to use.  Somehow, a miracle occurs and allows "stuff" to be bid up when people are making the same money (less in inflation terms).  I guess "they" will be doing the bidding and we will just be content to getting bent over for higher prices.

Remember, this situation is more or less permanent.  The dollar is going to zero and "stuff" is a good hedge against this phenomenon.

Here is the chart for dental crowns and bling:


Straight up.  It's 1979 all over again, but without the Bee Gees.  Yes, the inflationary thingy is the real deal.  Just look at gold.  It's doing exactly what the AM radio guys have always said it would do, and it isn't going to change, ever.  $2500/toz by the end of the year, and then onward and upward from there.  Buy it now while you still can, or you will be priced out forever.  Never mind that the dollar chart and the gold chart are not rigorously correlated. 

Have you noticed that gasoline is over $4? 

Hmmm...that's an interesting chart.  Oil has been frisky lately, and why not?  The dollar sucks and all the oil seems to be under the feet of rather unstable people.  Is this a dollar story?  In part, sure.  It is also a story of speculation on future price expectations.  Is this industrial demand?  Are we "demanding" more oil to make and move more "stuff," because we have extra money to demand it?

Doubt it.

Natural Gas
It seems that not all hydrocarbons got the message.  Again, this chart is interesting.  Can anyone say "what" is interesting about these two hydrocarbon charts?  Something big is sticking right out at us.  What is it?  Why is it significant?

Moving on to the softer commodities...

What's up with this?  You see something interesting in most of these commodity charts.  You see that the softer commodities (stuff you need for eating purposes) are not tracking the imminent demise of our currency, like gold is.  Some of this stuff has been selling off pretty hard lately (remember, these are weekly charts).  More importantly, these charts show something facinating and telling.  Look at the summer of 2008.

We see the summer of 2008 with parabolic blowoffs in commodity prices that coincided with HEAVY manipulation by the FEDERAL RESERVE during the first half of that year.  When commods broke in July, the dollar went on a rampage through October.  The dollar went up, and went up hard.

UUP (a proxy for long US Dollar futures) shows this and is the basis for this article.

 Look at mid 2008.  See what happened to the dollar?  Now, go look back at those commodity charts, particularly oil and nat gas.  See what happened?  This occurred when the FED stopped meddling with the dollar and allowed banks to take their marks.  MER and LEH got killed during this time (BSC was already taken under in March).  Washington Mutual got the axe later that year.

There was no "printing" back in early 2008, nor is there now.  There was only the FED holding the prices of assets high so interest rates would stay low and keep the banks solvent.  That thesis has been demonstrated to death on this blog and nothing in the current landscape changes that.  As long as risk is not matched with return, the underlying currency will sell off until it does.  As long as Ben holds prices high (low return) with higher risk being manifest in the system, the dollar will sell.  This works as long as Ben can convince people to borrow dollars to buy assets.  If he can't convince you, he will force you via the government.

Let's drill into that UUP chart.  Here is the daily action.

There are two trends in this chart that are coming to a decision point.  The weekly chart showed a long-term channel (down) and the price is now exactly on the lower trendline.  The minor trend is a steeper decline from the beginning of 2011.  That trend intersects the lower trendline on the larger trend over the next two weeks.  Pay attention; this is important.

UUP - DAILY (Close up)
The past two days have seen UUP hit and bounce off the lower trendline.  If this signals reversal, we should see a small bounce that may turn back down and retest the lower trendline by the May OPEX.  If it blows through to the north, we are looking at a 5 month rally in the dollar, which means a 5 month clubbing in asset prices (commodities, other currencies, equities, and debt).  Even with Bin Laden being killed and dumped at sea, the market rallied in the morning and then sold off.  The dollar did exactly what it should by dipping in the AM and then rallying to finish positive.  It is the inverse of the assets being played with borrowed dollars.  One would think the market would have been up 500 points on OBL being killed, but I guess there wasn't enough dollars to short to accomplish it.

What does the bond market say about this?  I'm glad you asked.

10 Yr US Treasury (Price)
That's the 10 year US Treasury as seen from a price perspective.  Price is the opposite of yield, so if you want to see what interest rates look like, just turn the chart upside down.

That was a monster drop from Thanksgiving and it has now formed a bearish flag.  That flag is due to hit the upper trendline in its channel over the next 7 trading days.  If it hits and turns south, rates will be going up and the dollar with it.  After all, if return closes the gap with risk, the currency will rise.  The downside target on this move, presuming it breaks out of the channel and completes the bear flag drop, is in the 108 area, which should be somewhere in the mid-4% range on yield.

I doubt the FED can stay liquid at those prices.  What happens then?  I have no idea, but whatever it is, it isn't good.

Oh yeah, one more thing...

Today, Turbo-Tax Timmy, our tax dodger in chief, said that he can pay the interest on the national debt without Congress raising the debt ceiling until at least August.  Even so, the Treasury can pay the debt service out of tax receipts, but other expenditures such as the defense of the nation, and paying 1/3 Americans not to work could be put on ice in order to free up the money for the bond holders.  That's an interesting scenario and one where a "dash for cash" could hit at the same time bond holders look at the future and wonder how much longer the government will pay them and allow the elderly, infirm, and meth-heads to wonder if the next check will clear.  They will get nervous and start slacking on bidding for new debt, in addition to the $3.5 trillion (that's with a "T") in short-term debt that has to be rolled in the near term.

That's a long way of saying that if Speaker Boehner grows a pair and he and Timmy get into a Richard-waving contest over the debt ceiling and $1.6T worth of new debt, the bond market is going to leave an upper-decker in every asset class in the world.

There are lots of things happening in the next 6 months.  If the dollar turns now, the asset markets are going to feel like a princess in a room full of poo flinging monkeys.  If the dollar continues to slide, there won't be much of an economy left.  Either way, it looks like the QE/recovery fantasy has about run its course.

There is no way to know for certain what will happen with the dollar.  All we can do is look for correlations and link weakness in manipulated asset classes with an imminent rise of the dollar.  It's a low probability event to call the corner.  Never confuse luck with skill.

Position:  Long UUP calls.

Thursday, March 31, 2011

Getting It Over With: IER Reviews Karl Denninger's Plan For Credit Market Recovery

Peer review:
a process of self-regulation by a profession or a process of evaluation involving qualified individuals within the relevant field. Peer review methods are employed to maintain standards, improve performance and provide credibility.
Today, we shall be reviewing Karl Denninger's "Four Point Plan" on how we can put this credit monster in the rear view mirror.

Citations of Denninger are taken from his podcast of July 20, 2009.  If anyone can forward the link to his actual white paper on the subject, I would be glad to refine my remarks to reflect more accurate and detailed information.

Summary:  Denninger's proposal is essentially an accelerated cleansing of our credit markets from the decades long debt binge that brought us here.  Think of it as a fiscal "porcelain princess hugging" after a three day bender with Charlie Sheen.  He makes no apologies for the abruptness of his approach and this is the primary feature so loved by the IER.  Essentially, Mr. Market is awakened from the morphine drip he has courtesy of the US Treasury and Federal Reserve, and weighs into the battle hopped up on Red Bull, khat, and that enormous pile of blow Tony Montana inhaled in the final scene of Scarface, taking no prisoners and leaving piles of red protoplasm where mortal men once stood.

POINT NUMBER ONE - Stabilizing Housing Prices.

Denninger called for Uncle Sugar to rewrite and backstop new loans for existing primary residences with the following features:

  • Existing mortgages - not new mortgages
  • Primary residences - not vacation homes, rentals, cottages, etc.
  • 4.5% / 30yr fixed.
  • Must qualify without FICO
  • Must qualify under 36% Debt to Income (DTI)
  • Loan rebased to the lower of outstanding balance or appraised value.
  • Marketable by Ginnie Mae
  • Borrower's credit hit on reset as if it was short-saled or foreclosed
  • This program runs for exactly six months.
  • All delinquent mortgages (defined as 90 days or greater delinquent) are to be foreclosed by the note holder and then have properties sold into the open market by auction, if necessary.

Assuming this is an accurate reflection of Denninger's first point, the IER likes it, but let's break this out point by point.

Forcing the banks (and we assume the money markets, retirement funds, and other investors) to take back and disgorge all the delinquent properties is an idea whose time is long overdue.  Approximately 14% of all housing in the United States is vacant.  That's 1 in 7.  Getting all this out into the market place at auction will bring about cash sales with very low prices.  We are talking about prices that make living in a house cheaper than living in a Ford Econoline down by the river.  Most of them will be snapped up by PEOPLE WHO HAVE SAVED CASH AND AVOIDED DEBT!!!  Perhaps Generation Y can finally move out of their mother's basement and surf the porn sites and play D&D in their own homes.

I'd go a step further and require, as a condition of non-judicial foreclosure, that the institution so foreclosing must sell the property to a disinterested third party no later than 183 days after taking possession.  No bank licensed to do business in the state can hold REO longer than 183 days.  If the bank can't sell it via Cookie and Candi, then the sheriff sells it on the courthouse steps.

Those who find themselves holding title to a bunch of new properties at fabulous prices will now have the ability to either fix them up and sell them for a tidy profit, thus establishing the new baseline for housing of that class, or rent them out for a very appealing ROI and have true income properties.  Go long HD stock.

This provision would certainly turn any large lending institution or retirement fund into a road pizza, but new banks would pop up and take their place.  Prudence is rewarded while tomfoolery is punished - exactly the way it should be.  Current home owners, including those that refied under Denninger's Ginnie Mae provision, would be massively underwater.  This changes nothing in this regard other than the timing.  This just gets us to where we are going in a faster manner. 

Anyone who has partied a little too hard knows all too well the Technicolor yawn is coming sooner or later, so just stick your fingers down your throat and get it over with.  There is no way to avoid this outcome.  Imprudent banks and homeowners (lending and buying at the peak) are facing this reality.  The only game we are playing is a multi-trillion dollar game of musical chairs.  Either way, the problem is still there, we are only determining whose butt isn't in a chair when the music stops.  Someone has to take the hit, so let it be the ones that loaned and purchased at the peak, rather than suckering in those who didn't.  Cosmic justice, folks...cosmic justice.  It's how an intact society is passed from one generation to another.

The idea that new housing loans must conform to a framework of sane lending is also a fantastic idea and Denninger has been pounding the table on this for at least 4 years.  36% DTI (back end) is a great place to start.  This would certainly cut off those recent graduates from the local degree mill who have racked up over $100 grand in non-dischargeable debt from qualifying.  Believe it or not, this is a good thing.  First off, it will reduce the price of homes in the lower tier to reflect the lower demand.  It will allow those who prudently managed college debt to enter into a higher strata of home, and it will put some curb on Big Ed, as kiddies won't want to tie on that much debt just to have a degree in Ancient Peruvian Poetry or Ethno-psychobabble.

I've been following Denninger for the last 4 years and know that he also advocates (and I assume is implied in his plan) that 28% of income be the limit for housing costs, which includes maintenance and some utilities.  That would also clamp down on home prices.  People would have to qualify on both counts.  He also believes that a hard 20% CASH down payment (not another loan or PMI) be part of qualifying.  This is essential because it goes to the heart of showing how a couple can save for the unforeseen event, but more important to our discussion, it puts quite a bit of borrower skin in the game while giving the banks plenty of lead time to grab and sell that home in the event of delinquency.  In this case, the borrower is ruined, not the bank.

The 20% down requirement would have single-handedly saved the banks in 2008.  NONE of the banks would have swirled the bowl, because the 20% down requirement would not have allowed prices to escalate to unsustainable levels and the entire brunt of it would have been borne by the borrowers.  Risk management is always said to contain two components:  frequency and magnitude.  I say that prudent risk management contains a third element - placement.  I can manage likelihood and enormity a lot better if I can place that risk on someone else.  In this case, the borrower sustains all the risk.  That's a risk management profile any banker should love.

I scratched my head and wondered why Denninger wants Uncle Sugar, who is already tapped out to the tune of $14 trillion, to underwrite more paper.  At first, I assumed his better angels were winning the day and he was trying to save homes for those who genuinely want them for the purposes of living, not speculating.  He ameliorates the seemingly goodie-goodie program by insisting that the new loan be marketable into the secondary market but only for the amount of the outstanding or appraised value.  I queried Denninger about this and he had an interesting take.

He is not looking at the humanitarian issues, but is looking at the unbridled jackassery the Treasury Department displayed when it changed the "implied" guarantee of Fanron and Fredron paper to an "explicit" one back in 2008.  His program rewrites the existing mortgages Uncle Sugar is presently underwriting and shifts the bulk of the burden over to the borrower.  He believes we can get out for probably 10 cents on the dollar compared to what we are presently doing.  This is probably the closest we will get to undoing Fan/Fred, so this gets top marks.

Any plan to reissue mortgages based upon appraisals must carry very strict guidelines and harsh penalties to prevent and punish abuse.  I promise you that any program that will have Uncle Sugar cosign based upon an appraiser's value will be rife with wall-to-wall fraud.  If anyone thought that the appraisers were pressured by Candi and Cookie to "hit the number" during the go-go years, they have not seen anything yet.  If I read Denninger correctly, your garden variety appraiser is going to be able to sign for the full faith and credit of the US government, so they had better be very tightly regulated.

He also says that the new loans would be rebased on a 4.5% 30 year product.  I'll assume the 4.5% was just a number that represents the current 30 year rate, as it has changed since he published his four points.  Either way, anyone who buys this paper at par for 4.5% or even 5.5% is going to take an instant bath when interest rates shoot the moon during the rebasing of the housing prices over the following year.  They will know this going in, so the only people buying this paper will be those who absolutely know for an iron clad fact that they will not sell it over its entire life.  Additionally, all those people who qualified under the new (or shall we say old) origination standards (28/36% DTI, 20%, verifiable employment history, etc) are going to be underwater and might have second thoughts about holding the house that just lost another 50% over the next 18 months.  I'm betting that performance on those would be no better than the marine mammal fecal tranche of all those CDOs that went "splat" during 2008.  It is implied that Uncle Sugar has recourse against the borrower under this plan to ensure performance of a debt instrument backed by the government.  Why not?  It presently does against those who borrowed money for a post-adolescent Bacchanalia at Beer Bong State U, so this is not a stretch.

Lower prices would free up consumer discretionary spending and savings.  That spells higher margins and more capital investment - both are going to be needed to kick start the economy.  One of the main reasons the economy stinks is that housing is NOT an investment, but it has tied up all our capital.  Higher housing prices are no more conducive to economic growth than higher energy prices or higher food prices.  Using this market clearing mechanism should be the centerpoint of any government sponsored "recovery plan."  The previous "painless" incarnations of economic recovery have only made things worse.  Pain is part of economics and is a good thing.  It teaches prudence in the same way your central nervous system teaches you not to shave with a cheese grater.


No credit cards (or other forms of unsecured debt) can be issued for more than 10% (1000bps) over current FED FUNDS.

I like this and give it the IER seal of excellence.  Here is why.

Any bank that can't make a profit on their plastic with the swipe fees and 1000bps over their overnight rate has bigger problems than deadbeat mall rats.  I've had a credit card since 1986 and have yet to carry a balance over from month to month.  Total interest paid since 1986?  $0.00.  Not one dime.  Total amount of defaulted credit card debt?  $0.00.

My credit card company makes plenty of scratch on the swipe fees, since I put almost every transaction on the plastic.  So, now that I have shattered the humeral head of my right arm patting myself on the back, why is this important? 

It puts banks back in the business of hiring black hearted meanies to deny people credit.  Perhaps we don't need to be issuing every college kid a credit card with a 5 digit limit.  Perhaps banks need to withdraw credit cards when people don't pay, or lower their credit limits.

In other words, treat credit as a luxury of the responsible, rather than a right of the Great Unwashed.  We need to incentivize the less credit worthy to save and use cash in order to develop the skills of handling their spending in a more responsible manner rather than reinforcing mindless consumerism and allowing those least capable to live beyond their means.

If banks can't subscribe the risk for a customer with FF+10, they shouldn't issue the card.

POINT NUMBER THREE - Repeal Bankruptcy Reform

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was Grade AAA legislative raw sewage.  This was written by MBNA and it shows.

Bottom line:  make debts dischargeable and the lenders will be much more choosy about lending.  This follows all the same philosophical underpinnings of the previous two points, and Denninger is spot on.  This is not populist smack-talk, but forcing bankers to do their jobs and occasionally say "no" when prudent.  I am comfortable speaking for Denninger on this point when I say that banks are debt merchants and they obviously want to sell as much product as is possible.  They also need to bear the risk for issuing their product.  I know for a fact that Denninger is an advocate of prudent risk management in the business sector and on this point he also gets a gold star from the IER.


Banks can not be run as high octane hedge funds nor can speculation firms have deposits guaranteed by the US government. 

Banking and "investment banking" (trading firms and hedge funds) are two distinct and separate business models.  One is in the business of shunning risk and the other is in the business of trading risk, so it stand to reason not to allow the two to co-mingle funds.

Again, spot on.  Banks can originate their own loans and sell them off as whole loans.  Collateral (trust deeds) must not be derivatives or amalgamated, but must be sold whole, by wet ink signature and in accordance with state law.  Banks are free to hold their own debt, but not buy speculative debt or derivatives such as Credit Default Swaps on speculative debt.

Investment banks do not take deposits insured by the government nor are they allowed to speculate in a manner that puts them in a position to make demands on the FF&C of the government.  They may trade their own unleveraged capital in any manner they wish, but no access to any bailouts of any form may occur.  If they blow up, they do so without any obligation of the public to make them whole.

The entire reason this provision was repealed in November 1999 was to increase leverage to keep the wave of liquidity washing over the financial markets rolling and to underpin other unsustainable laws, such as the Community Reinvestment Act.

All in all, Denninger is on the right track.  I'd like to share his optimism for the marketability of the new Ginnie Mae mortgages just prior to a controlled detonation, but other than that, he nails it. 

Open up and say "Ahhh," America.  It's time to blow chunks.

Thursday, March 24, 2011

Nobody Makes A Commission for Moving You To Cash

I know, I know...the IER has been dormant since the Seachickens butterfingered their way out of the playoffs, and the vast and loyal readership of the Westsound's premier economic blog have been jonesing for a fix. Here is a little bit of sanity to tide all of you over until the senior fellows can unclog their inboxes and devote the time needed to keep all of us in the right frame of mind.

I am in the finishing stages of a woodworking tour de force, and have been spending my spare time trying to keep all ten digits attached to my hands as I finish off my 13yo daughter's desk.  It has a leather top, 6 hidden compartments, lever actuators, dovetailed drawers, etc.  During the time in the woodshop, I listen to a fair amount of AM talk radio, just as I have for most of my adult life.  I'm starting to understand that the best fade might be the advertisers on AM radio.

In the final stages of the housing bubble blowoff, we had some fiscal menace with a Georgian accent advertising the "biggest no brainer in the history of Earth," which was just a cash-out-refi scheme to use your house as an ATM.  Let the record show that scheme didn't end so well.  There wasn't a commercial on the air that wasn't some form of housing bubble get-rich-quick scheme.  It got so bad that I had to create a "kill switch" for my radio so I didn't wear out the concrete floor of my garage dashing to and fro in a desperate effort not to hear the K-I-E-L Mortgage jingle.

Well, as the vast and loyal readership of Clearcut Bainbridge know, I'm not drinking the goldbug Flavor-Aid, no matter how many times the yellow metal is pimped on the radio.  I lived in a rental during the housing blowoff (and had to endure the unceasing torrent of finger wags from every shoeshine boy/home owner/RE agent in Western Washington) and in a similar fashion, I am in cash during this idiocy.  Apparently, it's finger wagging season once again.  The US dollar is going to be worthless, dontcha know...

OK, let's get on with the facts.

First off, let's bring out the favorite chart of the goldbugs.  Let's talk about how the US dollar always inflates and therefore you must own something "hard" to compensate for the inexorable fall of the dollar.

As anyone who has completed the 5th grade (7th grade if you went to Port Orchard schools) can plainly see, the US dollar is about as hard as the Stay Puffed Marshmallow Man.  Why golly gee...every single year sees the dollar get smaller and smaller, and look at that "hyperinflation" of the 1970s!!!

Never mind that gold got crushed, and I mean CRUSHED, by the Stay Puffed Marshmallow Man from 1980 to 2002, even though the US dollar got weaker every single year.

How can that be?  After all, gold (or any "hard" asset) is a shelter against inflation.  Right?  Mike Medved says so.

Now is the time for goldbugs to go out and Google "cognitive dissonance" and do a 5 paragraph essay on the subject.

In the meantime, let's extend our X axis out to the left a few years.

 I guess we do get deflation from time to time.  The financial crisis of 1920 was very severe, but it was short lived.  The credit expansion for the worst foreign policy in US history was being corrected by the market with a dollar that was RISING IN VALUE.  We then got the "Roaring 20s" and the rest of the excess was removed during the Hoover Administration.  Had it not been for the arbitrary and capricious nature of the New Deal, we likely would have pulled out of the Great Depression with the rest of the civilized world.  We see credit expansion during WW2, and then a general rise of inflationary expansion to the modern day.

It is the IER's opinion that this massive move of credit expansion ("inflation" to you goldbugs) is really nothing more than leverage upon leverage.  We are avoiding credit contraction ("deflation") by force-feeding CREDIT, not cash, into the system.  Let's do that one more time, but with more elan:

Americans are piling on more and more debt of a riskier and riskier nature to prevent the inevitable and mathematically certain consequences of credit expansion - credit contraction.  After all, the best way to avoid hangovers is to just keep getting really, really wasted.  This is exactly what came to pass in 2008.  Hank and Ben moved us to a more reckless position to take on even more debt to prevent the natural consequences of seculum-long debt binge.  Can anyone say that Hank and Ben did anything other than take on more debt to "fix" the financial crisis of 2008?  Anyone?  Sure, they transferred a bunch of it to the US Treasury, but it is still there, just a different bag holder.

Now, for those who don't like the feeling of blood draining out of your head, you might want to skip the next chart.

My, oh my.  What have we here?  It looks as if the natural consequence of credit-expansion is credit-contraction, and the anomaly isn't deflation, but sustained "inflation."  It would appear that the green ink and blue ink are roughly at parity until we get to WW2, when we get a very long credit-expansion boom.

As we say around the IER, "The boom causes the bust."  Now you know why.  The higher you throw the rock into the air, the harder it hits the ground when it returns to parity. Guess how high we have thrown the current "rock" into the air?  Oh, yeah...

Gentlemen, deploy your barf bags.  When Tim and Ben quit their multi-trillion dollar juggling act, the suckmeter is going to be pegged.

As for now, if you are holding cash, you just have to be at peace with the goldbugs having their time in the sun.  Make no mistake, the repercussions of a credit-contraction on this scale will be positively epic.  Picture what happens when Uncle Sugar can't borrow 42 cents of every dollar he spends.  Pax Americana will get cut, but the real bloodletting will be in entitlements, particularly Medicare and Social Security.  Sorry, but the math doesn't lie.  The suckmeter will be pegged, and that is no understatement.  Picture California without welfare checks...Picture Pike Place Market grommet-heads with no trust fund...Methinks granny is going to move back in with the kids and grand kids, and that ain't bullish for housing.

Perhaps if we just allowed the periodical, natural cleansing of credit-contraction to occur when the market dictates, we wouldn't have this problem, hmmm? (done in my best Dana Carvey "Church Lady" voice)  I'd like to think we would all be better off if the suckmeter needle stayed in the green arc on the gauge, rather than blow right through the amber range, the red range, fuse itself to the peg, and have the gauge explode because it sucks so bad.  This is how you teach fiscal discipline to the next generation.  Those that overdo it on the debt binge get taken out, chopped up, and sold to their cash-laden, well managed competitors.

I will say that the "hyper inflation" meme isn't an impossibility.  If the US government prints up strawberry scented welfare checks denominated in $100,000 increments and sends them out to everyone in the US, I'm on board with the whole "inflation" concept.  Granted, that presumes it stays in circulation.  It also presumes that people will just pay $40 for a gallon of gasoline, and that their employer will pay them $200 per hour.  Good luck with that scenario.  My employer can barely make payroll because of high input costs (Jet-A), so that fancy-schmancy 50% pay raise my union is asking for isn't really being taken seriously.

What is the moral to our story?  All these dire predictions of doom and gloom, coupled with "hyper inflation" are just goldbugs trying to sell you something.  Just as the scary prediction of "buy now or be priced out forever" came from Cooki and Candi, the wonder-twin RE agents, because they were trying to sell you something, the same scare mongering about "hyper inflation" is now coming from the metalheads.  Remember, there is no "sell side" analysis on Wall Street because nobody makes a commission for moving your portfolio to cash.

Every time you turn on the lobotomy box, radio, computer, newspaper, etc, you are being sold something.  Someone is trying to separate you from your money.  Cash doesn't have a salesman.  Food for thought.