Government Spending, GDP and Nonsense In Between Them The Year of Living Quantitatively The Amphora Report’s 2010 Topics in Review (1 of 4)
Home . Archives . Unsubscribe The Daily Reckoning | Tuesday, December 28, 2010 The Daily Reckoning Presents: Another installment of our Best Of Series
for 2010. In this musing, our publisher, Addison Wiggin, offers some
insights and words of warning on "the crisis to be" in the months and
years ahead. Please enjoy...Son of Subprime AddisonWiggin Bill Bonner More Risk Appetite for Fiscal Gluttons
Reckoning from Los Perros, Nicaragua...Bill Bonner
This week, between Christmas and New Years, is always slow. Traders have mostly taken the week off. The Dow was down a little yesterday. Gold was up a little. Nothing to get excited about.
Here's a guy who should have taken off too. Bloomberg reports:
"QE2 has had unforeseen benefits in raising risk appetites and improving confidence across the board," said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services, which oversees $9.5 billion.
What? Unforeseen benefits? Those are exactly the flimflam benefits the Fed promised. Put more money in the system; hope it causes "animal spirits" to pick up.
How do increased "risk appetites" really help anything? The US economy gorged itself on risk during the bubble years. The Fed should be helping it stay on a diet; not waving chocolate éclairs in front of the slob's nose.
But we're already beginning to apply our New Year's Resolution for 2011. We're going to improve ourself. We're not going to be so critical (see below).
Yeah...more risk appetite. Sure. Why not? Just what we need, right? We need speculators to make bigger bets. We need homeowners to take chances again - buy a new house...flip one or two of them... Who knows; maybe they'll go up. And we need consumers to buy things they don't need with money they don't have.
Yeah...that's just what we need - more credit-fueled risk-taking. Thanks for bringing that to our attention, Mr. MacQueen.
And more thoughts...
"Family get-togethers are difficult, because families are difficult," said Elizabeth.
Christmas snuck up on us. On the eve, we were still wrapping presents. Then, at about 8 PM we settled down to watch a movie - Christmas Vacation, with Chevy Chase.
"Family Christmases can be intense," Elizabeth continued.
Maybe it is true of all family get-togethers. Or maybe it is particularly true of Christmas. Our children are young adults. They have their own ideas now. They have their own personalities, their own standards and their own expectations. Mom and Dad may not measure up.
"It's not like it used to be. When the children were little we set the entire agenda. We directed the conversation. It was all up to us. It was our family.
"But the family is different now. We have a house full of people whom we can't completely control. They're adults.
"They're adults. But they're not entirely settled into adult life. They're not sure who they are. Or where they belong. Or how they should get along with their brothers, sisters and parents. Or whether we did a good job of bringing them up.
"It seems like they're testing each other...and us too."
*** "Dad, you are so negative...so critical..." Jules had said that afternoon. "I don't see how you can live with yourself. I would be very unhappy if I were you."
"What? I'm not negative. And I'm not unhappy," we replied
"Your father is usually cheerful," Elizabeth backed us up.
"He sure doesn't appear to be..."
"Of course, I'm cheerful... What do you think I am, some kind of Grinch or Scrooge? I'm an economist, for Pete's sake. I have to be cheerful.
"What... Do you think the negative GDP growth depresses me? Or Ben Bernanke's crackpot money printing? Or the phony 'stimulus' program? Or the idea that the same feds who had no idea what was happening are now running the whole world's fraudulent financial system?
"Nah... It doesn't bother me at all. Just the opposite. I HAVE to be positive. And cheerful. Otherwise I'd slit my wrists."
"Oh dad, you're always making jokes. But they're always dark jokes. They always have kind of sour twists to them. They are just your way of covering up your own gloomy personality."
"That's not true. Of course, I think that most of what goes on in public life is a fraud and a scam. But that doesn't mean that I think everything is a scam and a fraud. Private things - like spending Christmas with you and the rest of the family...or like looking at something beautiful, like the view out our front door...or when someone says something that is true...or does something that is genuinely brave or genuinely kind...
"...well, I appreciate these things as much as anyone. In fact, I appreciate them more than most people.
"You always have to separate the cheap and tawdry from what is really worthwhile. You can't recognize something that is beautiful unless you can also recognize something that is ugly. And you can't really appreciate the truth unless you can compare it to a lie.
"Trouble is, it's not all equally balanced out. For every truth, there are hundreds of lies. For every noble, honorable, sincere and intelligent man there are hundreds of jackasses."
"That seems like a very negative view, Dad..."
"Jules isn't really criticizing you," Elizabeth explained later. "He's a lot like you himself. He's probably just trying to think through how and why people are happy. In a way, he's testing himself..."
*** On Christmas Day we loaded into our cars and drove up the dirt road to Salinas. We were going to a new Catholic church for Christmas Mass. But the church looked so little like a church, and so much like an abandoned warehouse, that we drove right by. We had to stop twice for further directions.
The priest was a man with a face that looked vaguely like a South American dictator. He was a man of the cloth. But he might just as well have been a man of the machete or of the machine gun.
"Circumstances rule men; men do not rule circumstances," was how Herodotus put it.
If he had come along a few years earlier, he might have joined the Sandinista revolution. But that is now history. Only aging hippies and hallucinating communists still care about the Sandinistas. Daniel Ortega is back in office. But this time was elected. And now he's said to be more interested in money than in ideology.
The church had a new tin roof. It had a dirt floor. No windows or doors. The dust blew in with the wind, causing the choirboys to cover their noses and eyes. A pig wandered in during the reading of one of St. Paul's letters.
Our family made up about half the congregation.
"Most people go to church on Christmas Eve," said a nice woman in shorts. She might have added that most people also go to one of the competing churches - either the Apostolic church up the road...or the Evangelic church in the next village. The holy rollers are grabbing market share fast. They put on a better show. It was standing room only at one of them that we passed earlier. Mainstream churches are lagging behind.
We were going to report the sermon to you. But we couldn't remember a word of it.
"It was about salvation," Elizabeth reminded us. "The priest explained why Christ was born...why he came down to Earth...why he suffered. He had to join us in our suffering so he could deliver us from it."
"Why did he have to do that?"
"I don't know..."
*** After church, we turned off the dirt road at a sign indicating, improbably, a "Café de Paris." Even more improbably, there actually was a French café, on the ocean, run by a French couple, and housed in a building such as you would find in an African safari camp. It was curved, with solid white masonry walls and roof of "palapas" - thatched with palm fronds.
"We've been here for 24 years," the woman explained. "My husband got sent to Managua by his company. But then, when that was over, we didn't want to go back to France. Life is so much better here. We live on the beach. The weather is nice. We don't make much money, but who cares? We live the way we want."
The woman was very glad to see us. Most of her customers were backpackers. Maybe she was happy to see adults. Maybe she was just happy to speak French. She hugged Maria. She took your editor's arm. It was as if she had been on a deserted island for a quarter of a century.
"Please come back," she begged when we left.
Regards,
Bill Bonner,
for The Daily Reckoning
The feds spend more money and increase taxes to pay for the spending. This has a multiplier of “one” – or so they say – meaning, you get one times the benefit. Why do we bother to challenge it? The idea is delusional claptrap. No need to shout it down. It whispers “nonsense” to anyone who will listen. All we have to do is imagine what really happens...
A Visit from the Ghost of Economic Future
The One Nicaraguan Development That’s Doing Well
There are increasingly those who predict hyperinflation, which is popularly defined as rapidly-rising prices that soon reach un-payable levels, and which is always caused by the true definition of inflation, which is (according to the Mogambo Big Book Of Economic Stuff (MBBOES), “A gigantic growth in the money supply, which is caused by banks deliberately acting like greedy, lying, filthy pigs who deserve to be thrown in jail.”
Why Fed Money Creation Hurts the Poor Population
The Derivatives Market Monstrosity
In 14 editions of the Amphora Report this year we have covered nearly 30 topics, many of which overlap in some way. What binds them all into a coherent set is our view that the economic policies being implemented in nearly all major countries are not just unsustainable but in some cases outright reckless.
The Past: Abandoned Principles and Misguided Policies
Bargain Shopping in Peru, Chile and Brazil
Tuesday, 28 December 2010
[Reckoning on August 8, from Baltimore, Maryland]
In 2007, the writing was on the wall. The famous "perfect storm" had gathered above the US housing market, its eye hovering over subprime loans. As you know, the storm came...and it rained, and rained, and rained... Ultimately, it washed away trillions of dollars in investor wealth.
Now in an entirely different sector - probably the last place you'd look - the clouds are turning black once again. Strip out the finer details, and you'll find the very same mechanics that brought the subprime market from boom to bust:
This crisis-yet-to-be is...municipal bonds.
Munis have been a long-standing pillar of stable return. Only bonds from sovereign governments and blue chip corporations have a better reputation for credit-worthiness than munis. So when a city or state sells bonds to build a new school, sewer or stadium, investors form a line around the block. In the history of the union, only one US state has ever defaulted on its debt (Arkansas 1934). A few cities here and there have also done so. In other words, munis have performed admirably over the years.
But reputations, as this credit crisis has taught the world, no longer mean jack. Ask debt holders of "blue chip companies" like GM, or "sovereign" states like Greece. Investors are learning an old lesson the hard way: No asset class - not one in the history of the world - is a sure thing.
Though vast and complicated, the root of American municipalities is like any business or household: Money goes in, money goes out. Done right, a municipality takes in more money than it pays out. Money comes in mostly from taxes and revenue streams such as utilities and tolls. Money goes out to finance municipal government payrolls and public works programs. Cities and states sell bonds when they either can't pay upfront for such needs. No big deal...at least, it wasn't a big deal until recently.
In this era of high unemployment and shrinking economies, municipal revenues are hurting. Tax revenue tends to be lower with 15 million Americans out of work. Just the same, they use less power, drive through fewer tolls. Pay that parking ticket? I don't think so...not this year.
Not surprisingly, municipalities are struggling to cut spending in line with lost revenue. But their biggest expense of all is untouchable - pension plans. California offers a telling example. A recent Stanford study concluded that the state pension fund program is underfunded by roughly $500 billion. The researchers urged Gov. Schwarzenegger to inject $360 billion into its public benefit systems - right now - to have an 80% chance of meeting 80% of obligations over the next 16 years.
Facing a $20 billion state budget gap, what can he possibly do?
It's precisely this pickle that undid Vallejo. The San Francisco suburb declared bankruptcy in 2008. Tax revenue had collapsed, a major shipyard closed and all of a sudden the city found itself paying 90% of its annual budget to retired public employee pensions. 90%!
The problem, just like with subprime, is an irrational form of leverage. In essence, municipalities borrow current earnings of public employees in exchange for some of the most favorable retirement plans in the world. That borrowed money is invested aggressively, just like a private-sector employee would in his 401(k).
Except if the fund loses money, which they all have over the last 10 years, pension funds don't adjust payouts. The social and political pressure to maintain the status quo - keeping our public employees comfortably retired - is just too strong.
So municipalities kick the can down the road. New employees buy into the funds. Fund managers maintain their projections of endless 8% annual returns. Retirees keep taking out the funds they were promised...and no one pays the tab.
And it's not just California. Orin Cramer, chairman of New Jersey's pension program, estimates a national funding gap around $2 trillion.
The municipal bond market is roughly $2.7 trillion. If Cramer is on target, that's a total liability about the size of France and Britain's annual GDP - combined.
Therefore, in yet another subprime redux, Wall Street has found a way to make the muni bond problem even worse. Like the mortgage market, the municipal bond market has morphed into its own new era of highflying finance, adjustable-rate loans and complex securities.
For proof, read "Looting Main Street," a recent Matt Taibbi expose in Rolling Stone. How could a $250 million sewer project leave taxpayers on the hook for $5 billion? Easy - if you're a Wall Street bank and you engineer a "synthetic rate swap" deal. It brought Jefferson County, Alabama, to its knees:
The county got the stability of a fixed rate, while paying Wall Street to assume the risk of the variable rates on its bonds. That's the synthetic part. The trouble lies in the rate swap. The deal only works if the two variable rates - the one you get from the bank, and the one you owe to bondholders - actually match. It's like gambling on the weather. If your bondholders are expecting you to pay an interest rate based on the average temperature in Alabama, you don't do a rate swap with a bank that gives you back a rate pegged to the temperature in Nome, Alaska.
That's the "beauty" of modern lending. This deal, struck by JP Morgan, allows a cash-strapped county to upgrade to a world-class sewage system it could otherwise never afford. The extra costs - the fees, adjustable rates and superfluous debts... That's a problem for the next generation. Just like the state pension fund.
And as Taibbi also observed, banks pull in millions upon millions in fees for structuring these loans and swaps. Bonuses live and die by such deals. Just like the 2005 mortgage market, there is both intense demand for new age municipal financing - and remarkable incentive for Wall Street to "help out."
Of course, what modern catastrophe is complete without a credit ratings debacle? According to the National Conference of State Legislatures, 34 states are projecting budget gaps for 2010. The total shortfall will likely exceed $84 billion. Yet only two US states, California and Illinois, are currently rated lower than AA by Standard & Poor's. Only four states have fully funded pension programs. Yet 11 have S&P's coveted AAA credit rating.
Given all that we've explored above, and the ratings agencies' track record over the last 10 years, those AA and AAA ratings seem woefully optimistic. Insolvent is insolvent, not matter what the rating agency's say.
For the conservative investor, therefore, our advice is straightforward: Avoid municipal bonds. For the speculating investor, check back in tomorrow to learn about a risky way to bet against the municipal bond market.
Regards,
Addison Wiggin,
for The Daily Reckoning
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