By Bron Suchecki, on May 7th, 2009
From the latest Leithner Letter:
Given how we came to this pass, where Australia now stands, what the government is doing to us and what may lie before us, it’s difficult to conclude that stocks are cheap and easy to believe that they remain dear. True, the AOI is less overvalued now than it was, but “less overvalued” is not the same as “undervalued.” Accordingly, Leithner & Co.’s plans include the possibility that an environment marked by recession and stagflation (like the one that plagued the early 1970s to the mid-1980s) prevails during the next several years. In such a climate, the fair value of the All Ordinaries Index would be ca. 1,700-2,300. That implies a fall of ca. 70% from the Great Bubble’s maximum and the harshest bear market in Australian history. Furthermore, taking 2,000 as the AOI’s “bottom” and assuming a long-run growth rate of 7.5% per annum, ca. 17.5 years will pass before the Index returns to its Bubble maximum of ca. 6,850. If so, this will be the most fraught recovery in Australian history.
The newsletter is worth reading for the detailed analysis behind that conclusion – it is not just some number picked out of the air or drawing some trend line on a graph. It is not coincidental that the Directors of Leithner & Co are Austrians (as in economics).
By Bron Suchecki, on May 6th, 2009
Next to the Perth Mint’s CEO office is an old bookcase filled with many dusty titles from CEOs past. The title “The War on Gold” on the spine of one of them caught my eye today. Published in 1977 by Antony Sutton, it is a bit of a depressing read as little seems to have changed – consider these statements from its back cover:
* The US debt pyramid – what do municipal bonds, domestic bank, and other institutional failures mean for the price of gold?
* Confidence in the monetary system – is panic just around the corner?
* Manipulation of the market price – how long can the US Treasury keep the price of gold down?
* Gold and freedom – why totalitarians always forbid the private ownership of gold.
Same issues being discussed today, over 30 years later. Anyway, I found Mr Sutton’s glossary amusing. He prefaces it with the statement “Common words or phrases used by money manipulators, and their meaning is laymen’s language.” Some selections:
* A Crisis in Confidence – general public discovers it has be conned by politicians and bureaucrats.
* Run on the Bank – general public discovers it has been conned by the bankers.
* Hoarding – precautionary saving of wealth (usually gold) by individuals.
* Reserves – precautionary saving of gold by Governments.
By D H Smith, on May 6th, 2009
William McGurn wrote an article entitled “New Jersey Is the Perfect Bad Example” in the December 30 2008 edition of the Wall Street Journal. (http://tinyurl.com/94y8ll) It’s all good, but the really arresting part was this:
From 2000 to 2007, says the New Jersey Business & Industry Association, the government added 54,800 jobs. To put that in proper perspective, that works out to 93% of all jobs created in New Jersey over those seven years.
This statistic was picked up and widely discussed by radio and TV talkers, but the problems of one small and increasingly insignificant northeastern state are of little enough interest even to its residents, never mind the rest of America. Since then it has been swept away by the stimulus package, the budget, the stockmarket fall and rise, the G20, Susan Boyle, torture memos, Carrie Prejean, Somali pirates and Mahmoud Ahmedinejad. But as one of the people who hasn’t left yet, and who paid his real estate taxes today, I want to linger over New Jersey, the sorry state.
I’m never satisfied by what I read, but have to check myself. The info is there for the taking at one of my favorite websites, from the BLS, at http://www.bls.gov/data/#employment.
What I found, using different beginning and ending points, is more or less the same, with some other disconcerting data as well.
In the ten years to February 2009, non-farm employment in New Jersey rose by ninety-six thousand. Population rose around 320 thousand. Labor force participation rose in the middle of the ten years but fell later to end the period where it began at 47%.
State and municipal employment increased by 87,200 over the period which is 91% of the total increase. The federal government, the US Postal Service, and the Department of Defense all shed jobs in the garden state.
The goods producing sector of the state economy is in a total free-fall, losing 138,600 jobs in the decade, or 25% of all jobs in the goods producing sector at the beginning of the period.
One-third of manufacturing jobs were lost, and now government workers outnumber manufacturing workers five-to-two, making a mockery of the old motto “Trenton Makes, The World Takes.”
One-third of NJ workers now work for the government, or in health care which increasingly is much the same thing.
Does anybody imagine this state of affairs is satisfactory, or sustainable?
New Jersey’s population growth in the decade, at 3.8%, was barely one-third of national population growth. The state has the nation’s highest population density, so we can afford to let other places catch up on this measure. But to the extent that we are growing less because we offer an unattractive place to live, work, and do business, it is a problem.
Newark Mayor Cory Booker was quoted today by Bloomberg saying “New Jersey will go bankrupt in 10 to 20 years because we cannot afford our employees as a state. I’m talking about every worker from the cities and counties to the state government. Eventually, we’re going to price ourselves out as a government or tax ourselves to death.” Although he’s a Democrat, Booker talks like a pro-growth Republican. He gives the appearance of understanding that a diminishing private sector cannot indefinitely support a boundlessly growing public sector and hundreds of thousands reposing in the soft feather-bed of our ludicrously generous welfare state.
I wish him well. I like Newark, have done business in every neighborhood there, and know them so well at ground level that it horrifies my suburban Bergen County mother, who did her level best to prevent me ever knowing such places existed. The city of Newark is the biggest urban center of the state, but probably not the one that places the largest strain on the state’s finances on a per capita basis. Cory Booker deserves our support.
As for this state, it is Booker’s to run as governor in a future that is not too remote. No doubt he wants his prize to be worth something when he takes it in his hands. If he can get the ear of his party’s apparatchiks, maybe it can be. The trends, however, are not encouraging.
By Trace Mayer, on May 5th, 2009
At a Cambridge House Investment Conference I received a question about Bear Stearns. In my answer I alluded to the possible financial benefit of some from its implosion. When pressed I had to explain how credit default swaps worked and then we were out of time. Because the owners of the majority of the financial press have too much money to make from bankruptcies this topic is sparingly covered. But the Financial Times editor let an article wiggle through.
On 6 February 2009 the Kazakhstan Tenge went poof and was devalued by 18% in a single day. The currency has continued falling from 110 to the current 150.60241:FRN$1. The free-flowing credit to Eastern Europe ha stopped gushing months ago. Although BTA, Kazakhstan’s largest bank, was taken over by the government it still serviced its loans. BTA currently has total liabilities to credit institutions of 863,688,000,000 Kazakhstani tenge or about $5.7B. As the Financial Times reports:
“But last week Morgan Stanley and another bank suddenly demanded repayment. BTA was unable to comply, and thus tipped into partial default. That sparked fury among some other creditors and shocked some Kazakhs, who wondered why Morgan Stanley would have taken an action that seemed likely to create losses. One clue to the US bank’s motives, though, can be seen on the official website of the International Swaps and Derivatives Association. One page reveals that just after calling in the loan Morgan Stanley also asked ISDA to start formal proceedings to settle credit default swaps contracts written on BTA.”
CREDIT DEFAULT SWAPS
A credit default swap (CDS) is a credit derivative contract between two counterparties. The buyer makes periodic payments to the seller, and in return receives a payoff if an underlying financial instrument defaults. In effect, the owner of a credit default swap is short the underlying going concern.
Many of the largest Wall Street banks are heavily involved in the derivative markets with reported notional amounts outstanding as of 31 December 2008 for JP Morgan at $87.4T, Goldman Sachs at $30.2T and the single digit midgets of Bank of America and Citigroup at $38.3T and $31.9T, respectively.
The Financial Times reports, “As a result speculation is rife that Morgan might have deliberately provoked the default of BTA to profit on its CDS, since a default makes the US bank a net winner, not a loser as logic might suggest. Morgan Stanley, for its part, refuses to comment on this speculation (although its officials note that the bank does not generally take active “short” positions in its clients). And I personally have no way of knowing whether Morgan is short or long, since Morgan refuses to disclose details of its CDS holding. Right now more than $700 million BTA CDS contracts are registered with the Depositary Trust & Clearing Corp. in New York.”
This represents about 12.3% of the total liabilities to credit institutions. But later in the article the key point is hit upon: ”But the rub for regulators and investors is that BTA credit risk has not entirely disappeared: Somebody right now is holding the other side of Morgan Stanley’s contracts, and unfortunately there is little way for outsiders to know exactly who. Worse, the presence of those CDS contracts makes it fiendishly hard to work out what the true incentives of any creditors are. In theory, lenders should have an interest in avoiding default. In practice, CDS players do not. The credit world has become a hall of mirrors, where nothing is necessarily as it seems. At best, this makes it very difficult to tell how corporate defaults will affect banks; at worst, it creates the risk of needless value destruction as creditors tip companies into default.”
FAIR VALUE ACCOUNTING AND GEITHNER’S PLAN
Financial companies have used their agents, U.S. lawmakers, to pressure the FASB to relax fair-value accounting rules. The result has been the official endorsement of fair-value lying. Then with the other hand tax evader and Treasury Secretary Timothy Geithner has constructed a framework whereby politically privileged banks with worse than worthless toxic assets sell them for cash at an inflated fair value lying price to a self-funded Special Investment Vehicle (SIV), a similar entity as Enron used, that receives a non-collateralized loan from their government puppets.
HYPOTHETICAL
For the sake of argument and simplicity assume that Bank G loans Company M $1M in either a leveraged buyout or some other type of deal that was common over the past few years when credit flowed freely. Then Bank G purchases a CDS on Company M’s loan for $30,000 from Bank B and the CDS is reinsured by Insurance Company A.
Company M deteriorates because its free cash flow and a little more all goes to service debt and Bank G sells 90% of its loan to Bank J. Because credit risk has increased Company M’s bond now trades in the market for $25,000 and Bank J purchases a CDS from Bank L for the current market price of $60,000 and reinsured by Insurance Company A. Banks B and L go bankrupt, the trader at Bank L who sold Bank J the CDS now either goes to work at Bank J or receives consulting fees and the privileged creditors of Banks B and L, such as subsidiaries of Bank J and G, receive government bailout payments through Insurance Company A.
Company B, while still able to service its debt, does violate some provision of its debt covenant.
First, being friendly competitors Bank G and J decide to both press for default proceedings and then initiate settlement of the CDS they own.
Second, they fund a SIV with $25,000 of cash which borrows another $825,000 from the Bank’s government puppets.
Third, the SIV pays Banks G and J $850,000 of cash for the Company M loan which, while trading for $25,000 in the market is being carried on their balance sheet for $600,000 and consequently results in a $250,000 gain on the income statement for the quarter after having written down a couple quarters ago.
Fourth, Banks G and J receive $2M in bailout funds for the failed CDS contracts.
Fifth, Company M is completely evaporated and thousands of workers lose their jobs.
Total profit for Banks G and J: $2.85M-$1M-$30k-60k=$1.76M. Nice pay for a days work slaughtering and cremating a slight hobbling but otherwise generally healthy going concern.
FINANCIAL WMDs AND FINANCIAL TERRORISTS
As the great credit expansion continued it culminated in hundreds of trillions of dollars worth of derivative instruments. Some of these are registered while many, if not most, are not. These instruments are at the evaporating top of the liquidity pyramid while gold and silver are at the bottom tip.
Just imagine what the GLD ETF Authorized Participants, including Bear Stearns & Co. Inc., Lehman Brothers Inc., Citigroup Global Markets Inc., Merrill Lynch, Goldman Sachs, J.P. Morgan Securities, and Morgan Stanley & Co., will use the language in the prospectus to do.
These derivatives, with their fiendish counter-party risk, infest the balance sheets of almost every publicly traded corporation along with many local, state and national governments. Financial terrorists are greatly incentivized to detonate these financial weapons of mass destruction. Because Wall Street is full of a bunch of sociopaths and because you cannot grow a conscience if you do not have one therefore these sociopaths are very trigger happy.
POTENTIAL REMEDIES
When confronted with these type of financial terrorists society has often had to take powerful measures. For example, when John Law co-opted the French economy and tried to prevent its credit contraction by outlawing the use of gold and silver with the death penalty the French Revolution was sparked.
In the United States of America Section 19 of the Coinage Act of 1792 provided, “That if any of the gold or silver coins which shall be struck or coined at the said mint shall be debased or made worse as to the proportion of fine gold or fine silver therein contained, or shall be of less weight or value than the same ought to be pursuant to the directions of this act, through the default or with the connivance of any of the officers or persons who shall be employed at the said mint, for the purpose of profit or gain, or otherwise with a fraudulent intent, and if any of the said officers or persons shall embezzle any of the metals which shall at any time be committed to their charge for the purpose of being coined, or any of the coins which shall be struck or coined at the said mint, every such officer or person who shall commit any or either of the said offences, shall be deemed guilty of felony, and shall suffer death.”
Under Section 9 of that Act a Dollar is “to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy one grains and four sixteenth parts of a grain of pure, or four hundred and sixteen grains of standard silver.”
While the USA has 303M people about 2.3M are incarcerated or more than 1 in 100 American adults and it officially executed 59. On the other hand, the police state China has about 1.5M incarcerated adults and officially executed 3,400.
While China has had its problems it has not appeared to have had any serious problems with their domestic banks and derivative instruments. Perhaps a reason is because of how they deal with financial crimes. For example, the New York Times reported that Zheng Xiaoyu, former head of the State Food and Drug Administration in China, admitted to taking bribes to approve untested medicine and he was swiftly executed.
The suiciding of some financial executives, like David Kellermann of Freddie Mac, may help delay bond sales and toll time periods in CDS or other derivative contracts which could benefit certain privileged parties. But perhaps an official return of the death penalty for serious financial crimes would help curb some of the atrocious behavior by these financial terrorists who with premeditation and deliberation design, craft and trigger these financial weapons of mass destruction with absolute reckless disregard for both the individuals, companies, communities and nations which are affected.
CONCLUSION
Because the great credit contraction has begun, capital has started burrowing down the liquidity pyramid to safety and liquidity. Individuals, companies and governments have more leverage than they can sustain.
With the Federal Reserve refusing to comply with Bloomberg’s FOIA request for where trillions of dollars have gone and with JP Morgan, Goldman Sachs, Bank of America and Citigroup all acting like Morgan Stanely and ‘refuse to disclose’ it does beg the questions: What are the next companies to be slaughtered and cremated? How many hundreds of thousands of jobs will be lost as a result? What will the American people do about it?
Disclosures: Long physical gold and silver with no position in GLD, SLV, GS, C, BAC, JPM and MS. No credit default swaps or other similar position in Bear Stearns or Lehman Brothers and neither a job with nor consulting income from JP Morgan or Goldman Sachs.
By David Barr, on May 5th, 2009
If you have ever been to the loop area of Chicago you have probably noticed that there are a fair number of Starbucks locations. OK, that was a slight understatement. I can’t think of a single location in the Loop that is not within sighting distance of a Starbucks. Given the scarcity of retail space in Downtown Chicago, having three or four Starbucks locations on a single block hardly seems like an optimal allocation.
I am struggling to see the economic logic of extreme chain concentration. Surely the marginal revenue of an independent establishment would be greater than that of the 50th Starbucks within a relatively small area.
Since every location within the Loop is within two blocks of a Starbucks, I can’t imagine that a new location would attract many new customers. However, if one of the Starbucks were converted to an independent shop it would likely attract a large share of customers who preferred not going to Starbucks. Thus you would think that an independent shop would be willing to pay more to lease a location than Starbucks.
I can think of two possible explanations:
1. The major chains that dominate the area are engaged in an implicit price fixing. Basically, Starbucks and the other chains (I am looking at you Dunkin and Caribou) fear that any independent shops would significantly diminish their business. Thus when they open a new location they are really acting to freeze out any independent competitors.
2. Even though the expected return on investment is higher for an independent coffee shop the high price of commercial real estate may scare off many entrepreneurs. For a company like Starbucks committing to an expensive lease is not a great risk, but a local entrepreneur may be unwilling to take the same risk, preferring to locate to a cheaper neighborhood.
I don’t think that these two explanations tell the whole story, so I would be very curious to hear what other people think.
By Bron Suchecki, on May 4th, 2009
Tarek Saab, President of GoldandSilverNow, has posted an opinion on investor preference for Government issued bullion over private mints. Tarek favours private mints and discusses some of the arguments put forward for Government coins. As seems to be my habit, I offer come comments:
“If one doubts the integrity of our politicians and the financial system, why demand a coin issued with the full faith of the same architects manipulating it? … Instead of blindly accepting the markings on any coin, buyers should always be cautious.”
I agree with the last sentence, but the rest of the argument can easily be turned on private mints – greedy “private” banks, Enron, etc, there are plenty of examples of privately run companies that have defrauded consumers. The only thing that matters is the test of the market. I would suggest that investor preference for Government coins is probably because of decades of coins that have been of stated purity – can Tarek name one case of underweight or under purity coins? I think this proves that no matter what idiots are running the Government, they have not stooped to interfering with the integrity of their mints.
Of course, this is not to say that debasement cannot happen and investors should be alert to this. I think it is worth noting that the people running Government mints, just like their private counterparts, take their reputation seriously. All of them are part of the Mint Directors Conference and it is a small industry. It is my view that none of them would take kindly to politicians telling them to debase their coins – it would be an affront to their integrity and irreparably damage their reputation and career in the industry. If it was done, I would not be surprised to see whistleblowing, but if not certainly to see resignations, which is what I would suggest investors watch out for.
I think it is also improbable that politicians would bother to debase their precious metal coinage. Considering how little is produced, what would be the amount of money saved? Certainly it would be difficult to underweight the coins as this is easily detected, so reducing the purity would be how it is done but there is a limit to this. Again, this argument can also be turned on private mints – it could be argued that the profit motive provides more temptation to mint owners to save a few bucks by having slightly under purity coins.
In the end, I this the point Tarek is making is a double edged sword. Yes, politicians lie and are hard to trust, but if you are so poisoned by this lack of trust that you question all Government agencies, then I doubt that you will trust a profit seeking private owner of a mint.
“worried about dealers recognizing private-issue bullion”
On this point, Tarek is correct. Any decent bullion dealer should know all the products out there and their reputation. If the private coinage has a good name, a dealer should be willing to buy it back. Some may be conservative and buyback at bit of a discount, but this may also reflect the fact that there are not as many willing buyers. In any case, investors should always consider their exit strategy and on that basis ask those to whom you hope to sell, what they will pay for private issued bullion, then you will have no surprises.
“The face value of these coins is already inconsequential.”
True, but I think when someone says a coin is legal tender, it is just a way of saying they are Government issued and guaranteed.
“The availability of government bullion rises and falls dramatically with market conditions.”
So, this is because demand rises and falls and the same applies to private mints, probably more so as being profit focused they are less willing to sit on unsold stock. Tarek’s statement that dealers were put on waiting lists (and some Mints have moved to rationing instead of extending lead times) also applies to some private mints. I think the problems that Government mint have experienced reflects the fact that investors prefer their product over private mints, hence they have excessive demand. It would be my view that if demand shifted to these private mints then they would also experience availability issues. Northwest Territorial Mint is an example as they have had the same lead time blowouts as Government mints.
“Considering the risk involved with the default of any business in our present economic situation, and beyond that, the risk involved with the default in each business’ bank, I find it mystifying that investors would harbor the risk of floating hard-earned cash for lengthy periods of time.”
How is this an argument against Government mints? It is private enterprises that are failing and need Government bailouts. This is more an argument against leaving your money with private mints. Anyway, in this current market, any mint would have to be spectacularly mismanaged to lose money making coins and bars, so I don’t really think this is a big risk.
“many customers purchasing U.S. Eagles are now being asked for their social security numbers … the threat of a 1936 gold confiscation lingers like a bad toothache”
I doubt it is just about whether you are buying US Eagles, anti-money laundering rules would generally require identification of any bullion purchase – bar or coin, Government or private. It is how you buy it, not what you buy that matters. If your worried about confiscation, do it under the reporting threshold for cash and don’t have it mailed to you (otherwise records exist at the courier companies). It is also worth noting that is confiscation occurs, whether it is legal tender, privately issued, bars or coins, is not going to matter – they ain’t going to leave any loopholes.
One final point. Don’t take my comments above as an argument against private mints. The fact is that Government mints are generally conservative organisations and are thus a bit more cautious about making capital expenditure decisions to ramp up production in the face of increased demand. Private mints provide welcome flexibility and are probably more likely to want to take a risk on gearing up to meet demand. This is needed – as I point out in this blog, the industry as a whole was/is not ready for any significant increases in demand for gold coins. If gold ownership is to be more widespread, we need more capacity, and quickly as the rush could come any day if people lose confidence in the modern experiment with fiat currency.
I’m a firm believer in free and fair competition and certainly some Government mints could do with it and some will fear it, too bad. Let me close with a plug for the Perth Mint. Of all of them, the Perth Mint is probably best placed because while it is owned by a Government, is not subsidised and does not have a circulating currency business to help with cross-subsidising its products. Therefore it has had to survive by competing with private and Government mints and so is ready for the challenge.
By Winton Bates, on May 4th, 2009
Money is the medium of exchange as well as the unit of account and store of value. As the medium of exchange money makes life easy because we don’t have to spend a lot of time trying to find someone who is prepared to trade the goods we want to buy for the goods we want to sell. I have never been able to understand what Marshal McLuhan was talking about when he said “the medium is the message”, but the question I want to consider is whether we behave differently when we have money on our minds.
The idea that people may behave differently when they have money on their minds has a long history. Everyone has heard the biblical claim: “the love of money is the root of all evil”. What does this mean? This is not really an assertion that it is evil to collect coins, is it? It seems to me that the statement was not really about money at all but about the love of the worldly goods that money can buy.
The question of whether people behave differently when they have money on their minds also comes up in discussing when it is or is not appropriate to attempt to motivate other people using money. Tyler Cowen, for example, has used several parables to discuss this question, including the dirty dishes parable. Is paying one of your children a good way to ensure that the dishes are washed? Probably not. Children may feel less obligation to do their share of family chores if a voluntary exchange relationship is established in which the parent becomes an employer providing money in exchange for work, rather than a family leader “who is due some amount of obedience in his or her own right” (“Discover your Inner Economist”, p 14).
Is the payment of money intrinsic to this parable? I think that many economists would tend to say that the parable would apply in the same way if the child is paid in kind, e.g. in tickets to rock concerts, rather than in money. In the minds of many economists the issue would appear to be whether strict reciprocity is appropriate to the circumstances rather than about the method of payment that is used. Economists often say that money is a veil.
However, I am not sure that many parents would rule out all forms of bartering as being inappropriate as a means of motivating a child to do his or her share of family chores. It seems to me that bartering could be appropriate if it is about the things that parents do for their children that are beyond what might be generally considered to be the core responsibilities of a parent. For example, like many other parents, while my kids were in their teens I used a substantial part of my leisure time providing an unpaid taxi service to ferry them and their friends to and from various sporting and entertainment activities. Would it be inappropriate for a parent to suggest to a child that it would be unfair to expect provision of such services unless he or she does an appropriate share of family chores without having to be constantly reminded?
This raises the question of whether responses to provision of incentives have more to do with perceptions of the appropriateness of particular incentives than with concepts such as the strictness of reciprocity or the money value of the incentives provided. There is some evidence that actions that merely remind people of money can have a significant effect on behavior. For example, Kathleen Vohs, Nicole Meade and Miranda Goode report an experiment in which participants were primed by sitting at a desk facing posters showing various denominations of currency or posters showing either a seascape or a flower garden. The participants were then presented with a nine-item questionnaire in which each question asked them to choose between two leisure activities – an experience that only one person could enjoy and an experience that two or more people could enjoy together. Participants primed with the money poster tended to chose more individually focused experiences. The authors report similar results for eight other experiments (‘The psychological consequences of money’, Science, 318 (5802), 2006).
So what if responses to incentives are strongly influenced by perceptions of the form in which the incentive is provided and the language used when the offer is made? The most obvious implication is that a lot of care is required in selecting incentives that are perceived to be appropriate and in presenting them in an appropriate way to achieve the desired effect. There are quite different implications in relation to prevention of corruption. The ethics of accepting a bribe do not change merely because the incentive offered is more subtle than a bundle of notes in a brown paper bag.
By David Barr, on May 4th, 2009
Emmanuel Saez’s work on income inequality has been getting a lot of attention recently, for good reason. He has shown the extent to which inequality has grown rapidly in recent years. The benefit of economic growth this decade has gone almost exclusively to the extremely rich. The top 1% of the population now earn 25% of all income.
Yet I fear that this work may underestimate the true nature of inequality in our society. One of the flaw of much of the work on income and wealth distribution is that it fails to account for age. For example, my income is currently below the median household income; yet as a 23 year old with no dependents I am financially better off than the average American. The way that income and wealth distribution vary throughout the lifecycle of an age cohort is an important area where further research is needed.
In a perfect world everyone would start at the same place, as time passed differences would emerge due to talent, hard work and other elements of the meritocracy. Of course, that is not the world that we live in. Children born in wealthier families start life with a huge head start.
Marion Nestle recently noted that half of the children in America are currently eligible for government food aid. It is no secret that fertility rates in America are negatively correlated with income and education. Given the stark level of inequality present in America today, it stands to reason that inequality is even greater among newborns and young children than among the population at large.
This reality could have severe consequences for the future of the American economy and society. Numerous studies have shown how growing up in poverty can adversely affect a persons prospects for life. Is the future generation of Americans going to disproportionately suffer these consequences. Will the relative scarcity of Children from affluent backgrounds give those fortunate few an even larger advantage than the well off currently enjoy. Or will new opportunities open up to the children of the poor.
More research needs to be done to uncover the rates of inequality among households with young children, and to see how this rate has changed over time. A cohort based approach to income and inequality studies would provide a better understanding of how our society and economy is likely to evolve.
While more research is needed, I think it is clear that a significant commitment needs to be made to ensure that our future generation does not disproportionately grow up in poverty.
By Ajay Shah, on May 4th, 2009
There is a somewhat cliched old diagram that shows what we’re supposed to do when a bank gets into trouble. There are some nervous questions about this these days, but I still think the essence holds:
Solvent but illiquid
When a bank gets into trouble, the first question to ask is: Is it insolvent or is it just illiquid? If it’s merely illiquidity, then central banks should provide temporary liquidity support to a fundamentally sound firm. This liquidity backstop has always been a crucial role through which governments make the concept of a bank possible. The moral hazard involved here is controlled by making this liquidity support extremely expensive, so that banks should think thrice before using it.
These days, countries generally separate out the function of monetary policy, which is placed at an independent central bank, from the function of financial regulation and supervision which is placed at a financial regulator. In this case, a proper interface between the two agencies is required. To some extent, liquidity support is about merely having a central bank window where good quality assets are repoable at a penal rate (and with haircuts reflecting collateral risk). To some extent, this requires the financial regulator to make a call on whether a bank is merely illiquid or insolvent.
By Trace Mayer, on May 1st, 2009
BANKS HAVE MORE THAN ENOUGH CAPITAL
At a congressional oversight panel on the government’s financial rescue program the tax evading Treasury Secretary Timothy Geithner testified, “Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators.” With the recent fair-value lying accounting changes banks have reported surging quarterly profits. Even the single digit midget Bank of America booked a first quarter net income of $4.247 billion – 6% more than it made in all of 2008.
Olivier Garret, CEO of Casey Research, asks a couple penetrating questions and gives a couple answers.
“For starters, just where did all this income come from? And has credit quality really improved.
The answers to both can be found buried in a company press release bearing the encouraging title “Bank of America Earns $4.2 Billion in First Quarter.”
I’d like to draw your attention to the four most telling excerpts from this release.
- Equity investment income includes a $1.9 billion pretax gain on the sale of China Construction Bank (CCB) shares.”
- Noninterest income included $2.2 billion in gains related to mark-to-market adjustments on certain Merrill Lynch structured notes as a result of credit spreads widening.”
- Credit quality deteriorated further across all lines of business as housing prices continued to fall and the economic environment weakened.”
- Nonperforming assets were $25.7 billion compared with $18.2 billion at December 31, 2008 and $7.8 billion at March 31, 2008, reflecting the continued deterioration in portfolios tied to housing.”
BANKRUPT BANKS
Bank of America makes $4.2B almost completely from a one time sale of a Chinese bank and some accounting sorcery on Merrill’s failing mortgages. Looking at the cash position of Bank of America if those two extraordinary events were backed out and preferred dividends were included then Bank of America actually bled about $1.3B.
The head of the sorcery order, Goldman Sachs, was very creative by changing its reporting calendar which effectively erased the impact of $1.5B loss in December from showing up in its earning statements although it still flowed through to the balance sheet. Bank of America is not the only bank with these shenanigans.
The FDIC poltergeist possessed another four banks on Friday bringing the total for the year to 29. The evaporated banks that went poof were dotted across the nation holding about $1.6B in deposits including American Southern Bank of Kennesaw, GA with $104M in deposits, Heritage Bank of Farmington Hills, MI with $152M in deposits, First Bank of Beverly Hills in Calabasas, CA with $1B in deposits and the First Bank of Idaho in Ketchum, ID with $374M in deposits.
DETERIORATING CREDIT QUALITY
It is clear that credit quality continues to deteriorate at the banks and almost all banks are engaged in fraudulent accounting sorcery. On the bright side for these vampires, the steep yield curve helps generate tremendous real income for the banks as they are able to suck the life out of the remaining wealth generating companies in the economy.
JP Morgan reported a stunning profit because the value of their bonds declined in the market and Citigroup had a similar $2.5B gain.
MARKED DOWN BUT NOT ENOUGH
A few days ago I attended an art walk with some colleagues. While the funnel cakes, BBQ, smoothies and live music were fun we began to chatter about business.
 One of them happened to be a commercial property appraiser. He was telling me about the difficulty of appraising buildings because the market is failing to clear and data points are getting extremely scarce. For example, quarterly he appraises a beautiful 100,000+ square foot high-quality office building that overlooking the Pacific in Oceanside, CA.
Usually this premium building is never vacant but starting November 2008 its vacancy rate climbed to about 20%. He avoided a write down in Q4 2008 turning in a $64M appraisal. But because the vacancy rate, lack of comps, etc. is now typical for the market in Q1 2009 he had to evaporate $8M from the building turning in an appraisal of $56M and did not receive any complaint from the client. He told me he is currently working on the Q2 appraisal and figures he will need to evaporate another $4M. This is what happens to real estate values when the discounted future cash flows decline because of huge vacancies and leases being renegotiated.
NO BID THEN NO VALUE ASSESSMENT
My suggestion for valuing the building if the market was not clearing and there were no comps was a simple $0. Then I told him the story of my encounter with a senior partner from DLA Piper whose client had a 40+ story condominium that was worth less than worthless.
Why is there such an effort to keep the asset prices high? If these assets are being ‘held for the long-term’ then it should not matter if they are carried on the balance sheet at tremendously understated values. After all, Mr. Buffett often takes this approach.
I have never heard of an investor suing or regulator prosecuting fraud, except perhaps in divorce, tax or similar cases, because assets were undervalued on the balance sheets. They can always be marked up later or a gain can be taken at a sale. Additionally, this may even have beneficial tax consequences.
Of course, this type of accounting methodology may have a negative effect on fraudsters, Ponzi scam artists and fractional reserve bankers who are by definition engaged in embezzlement. These immoral individuals always want to misrepresent asset values to the upside but never the downside and prosecuting fractional reserve banking as embezzlement would be beneficial for society and lead to a more efficient allocation of resources.
ILLUSORY INCOME VERSUS REAL ASSETS
So let me get this straight: the greater depression is intentionally exacerbated with a skyrocketing unemployment rate, construction and commercial loans become impaired as projects are either stopped because the unsustainable consumer economy is grinding to a halt or phantom equity is evaporated. This causes the banks to either go under or become more of a credit risk. If the bank survives then it is an even a higher credit risk as their debt trades at a discount and that discount is booked as income. The banks record profits, CNBC declares all is well and the stock market soars.
By comparison, a consumer charges up a bunch of credit card debt at McDonald’s, loses their job, their credit worthiness diminishes and the bid for the consumer’s credit card debt in the market declines so the the consumer books income. Which begs three important questions: Is there any real income? Will a real economic loss be taken? By whom?
Wealth can take two forms: (1) a financial asset or (2) a tangible asset. Tangible assets have intrinsic value and can never become worthless.
Uncertainty from the lying on financial statements and by costumed government officials is briskly eroding the confidence of a inherently unsound confidence based system. In times like these there stands only one safe haven: commodity currency. At all times and in all circumstances gold and silver remain money. Their value is not subject to counter-party risk and accounting sorcery, unless it is fool’s gold or silver held in the GLD or SLV ETFs, and the metals will always buy something. Gold is the risk-free asset and does not require fraudulently induced confidence because it generates real confidence.
CONCLUSION
Fractional reserve banking is embezzlement and the accounting rules have changed to protect those engaged in fraud. The intrinsic value of the financial companies mentioned is almost impossible to accurately determine, may be nothing and therefore should be avoided. Asset values are rapidly evaporating and the credit quality of borrowers is quickly deteriorating which will lead to more banks failing. On 20 March 2009 FDIC Chairwoman Sheila Bair said some very scary words, “Without additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero.”
The Great Credit Contraction grinds on and holders of capital continue migrating down the liquidity pyramid seeking the safest and most liquid assets. Your electronic digits representing illusory currency are not safe in any of the fractional reserve banks and when the FDIC fails there will more pandemonium. With the FDIC begging to increase its line of credit from the Treasury from $30B to $500B the likely cure, whatever it may be, will inflict another laceration on the already mortally wounded FRN$ and further destroy wealth and hobble the economy.
During these relatively calm times for your businesses and daily transactions I recommend developing an alternative plan, and eventual substitute, to the current monetary system. For reducing your risk and keeping your capital safe there are three main options: (1) using gold and silver coins, (2) using the services of a full reserve institution, like GoldMoney, or (3) withdrawing the Federal Reserve Notes, putting them under the mattress and using cash as much as possible.
 Disclosures: Long physical gold and silver with no position in GS, JPM, BAC, C, CCB
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