Sunday, March 15, 2009

Reading Is Fundamental

Eureka! The Banking Industry’s Problems Are Solved!
Who knew it would be so easy? Who knew we could solve the banking industry’s collapse by simply changing how we account for assets. Eureka! Problem solved!

That seems to be the conclusion Wall Street came to earlier this week, judging by the reaction to Fed Chairman Ben Bernanke’s comments at the Council on Foreign Relations on Tuesday.

During that speech,... What Bernanke did is shift ever so slightly toward the position of the banking industry’s apologists.

The problem with the banks isn’t all the crappy securities and loans they’re loaded up with.

It’s not that they took on too much excessive risk, lending against assets whose value is plunging.

It’s not that they funded asinine private equity deals, stupid commercial construction deals, and dumb home purchases.

It’s that they have to mark their book of securities made up of these bundled loans to market. And they argue that the prices they could get for those securities in the markets are “artificially” low — or in some cases, that there is NO market for them.

If only they could avoid marking those assets to market, or use their super- duper net present value and cash flow MODELS — which, surprise, surprise, say the “real” value of those securities is higher — then the banking system would be fine. We could all go back to the wonderful world of yesteryear.

There’s just one problem …

Pretending Something’s Worth More Than It Is Doesn’t Change Reality!

Look, the problem isn’t that there’s NO market for these bad securities. The problem isn’t that the prices are “artificially” low. The problem isn’t how we account for these assets. The problem is that the industry doesn’t want to acknowledge that today’s prices are the REAL prices.

There are tons of bidders out there for this crappy paper … at the RIGHT price. Vulture funds, hedge funds, private equity investors: They’re all raising billions and billions of dollars to scoop up cheap real estate, inexpensive bundles of mortgage backed securities, and distressed buyout loans.

But sellers don’t want to admit reality. They’re not hitting the buyer’s bids. They’re hanging on to the garbage securities, hoping against hope that they won’t have to sell at the true market prices. And the government is busy trying to figure out ways to prop up the price of the garbage rather than forcing banks to take their medicine now, even if it means the result is that they have to temporarily be nationalized or put into receivership.’s-problems-are-solved-2-32610

Mark-to-market changes: Don’t count on a solution
With current accounting standards, banks must account for their assets, like bundles of mortgages and risky loans, at today’s prices. But nobody really knows what today’s prices are. After all, nobody is buying anything. That means banks have been forced to write down many of their least-liquid assets to nearly zero, the only price they know they could get.

But if the accounting rules are suspended, oh boy, banks could value those same assets at just about any price. Because there is no liquid market, finding a true fair price is nearly impossible. If a bank says its mortgages are worth six trillion dollars that is the price its balance sheet will portray. It will not matter if those same assets are listed as just a million dollars of value today.

Investors want to suspend mark-to-market accounting because it will lift valuations by huge proportions. As soon as the regulation is lifted, corporate accountants can start adding multiple zeros to all sorts of assets. And of course, those zeros would find their way to share prices.

With just one change in regulations, investors would go flooding back into the financial sector and send the equities market surging. It would make Washington look like the savior it has promised to be.

Of course, the gains would only be temporary. Before too long, the newly created bubble would burst and things would start crashing down once again. Even worse, investors would have no way to tell how accurate the new figures are. Without mark-to-market rules, there is nothing stopping a company from flat-out lying about its valuations. Enron’s books would look like a little, white lie.

Remember, mark-to-market is merely an accounting rule. It simply tells us how to price things on corporate balance sheets. It does absolutely nothing to represent cash flows. If banks are not able to rake in the kind of revenue an investor would expect from the newly created balance sheet figures (which is certainly going to be the case with the huge level of foreclosures and loan defaults), a revision in the law will do no good.

An accountant’s books are supposed to be a window into a company’s true value. If we paint a pretty picture on that window by lifting current accounting regulations, the same ugly scene will lie behind the glass.

China 'worried' about safety of US assets
Wen Jiabao, China's prime minister, issued a veiled warning to America yesterday to maintain control over its economy in the latest sign the global economic crisis is testing the most important bilateral relationship in the world.

In forthright remarks on the intertwined nature of US and Chinese finances, Wen told a news conference he was "worried" about Beijing's holdings of American government debt. Analysts believe China has $1trn (£716bn) of US treasury bills in its coffers, implying a delicate balance between two powers whose fortunes are interlinked.

Speaking at an annual press conference at the end of China's rubber-stamp parliament, Wen said: "President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures.

"We have lent a huge amount of money to the US. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried." In rare comments on another country's financial health, he added: "I'd like to take this opportunity here to implore the United States ... to honour its words, stay a credible nation and ensure the safety of Chinese assets."

Obama Reassures Countries on U.S. Debt
WASHINGTON — President Obama reassured China and other countries on Saturday that their investments in United States government debt were safe as he seeks to finance record deficit spending to pull the American economy out of its deep recession.

“There’s a reason why even in the midst of this economic crisis, you’ve seen actual increases in investment flows here into the United States,” Mr. Obama told reporters. “I think it’s a recognition that the stability not only of our economic system but our political system is extraordinary.”

He added, “Not just the Chinese government, but every investor can have absolute confidence in the soundness of investments in the United States.”

Opinion: A Demand with Serious Implications
With Wen Jiabao demanding that Barack Obama do something to assure China that the one trillion dollars of US debt they own won’t depreciate, an air of insecurity that has for the most part remained in financial districts has spread to political capitals

Chinese Prime Minister
Wen Jiabao said Friday March 13th that he fears the US dollar may lose its value, and as a result has asked US President Barack Obama to find new ways to reassure all those who have invested in the US dollar – and particularly the Chinese, who hold roughly one trillion dollars worth of US debt – that it will not lose its worth in the coming months and years.

There was no ‘or else’ added to Wen’s statement, but for any nation to question the value of the US dollar – as noted by the International Herald Tribune – is almost unheard of.

Of course none of this should be surprising. First of all, the reason that it is so rare for a nation to question the value of the US dollar is because for the first couple centuries of the US dollar’s existence, it was literally ‘as good as gold’. You could take your US dollar to a US bank and trade it in for solid, physical gold. But that all changes in 1913 with
the creation of the Federal Reserve.

The US dollar over the course of the last century has gone from being ‘as good as gold’ to ‘as good as Kleenex'; and what use does China have for one trillion ‘virtual’ sheets of Kleenex for? Hell, you can’t even blow your nose with virtual debt.

No longer can the US expect exporters to accept virtual Kleenex for goods and services. No longer can the US expect nations to buy their debt without assurances that this debt will not continually devalue. No longer can the US carry on as the global financial leader so long as their dollar isn't clearly reliable, and clearly secure.

However, there is no question that the value of the US dollar will continue to depreciate so long as the US continues to be a 'spend and consume' nation under a fiat financial system, and not an 'earn and save' nation under and intrinsically valued financial system.

Though all of this may seem obvious, it is clear that precious little is being done to fix the problems of too much debt and a sickly consumerist society. Just as obvious is that nations throughout the world will not stand by idly and see their once-wise investments turn into a pile of shi... Whoa nelson, I almost let one slip there!

If anything, we should be surprised that Wen’s statement didn’t include an ‘or else’, or at the very least a plan that would succeed in ‘assuring’ China that their investment would not wither into nothingness.

The Implications Of Treasury Bonds Hitting New Lows
Ben Bernanke has implied that the Federal Reserve would be willing to buy Treasury bonds should the need arise (i.e., Treasuries fall rapidly in price). He will do this by printing new US dollars. The reason that Bernanke is fearful of falling Treasury bond prices, and thus higher interest rates, is that higher interest rates would prevent an economic recovery. Although this plan could help to fund the Government’s $2 trillion deficit initially, there would be huge implications to the broader fixed income markets if the Federal Reserve were to buy Treasury bonds. Nevermind the negative effect on the dollar from the newly printed money, the crowding out effect on non-government fixed income markets could be devastating. Crowding out will occur because the number of markets that the Federal Reserve can support is limited and the amount of money that is necessary to keep Treasuries from falling is staggering.

As we get closer to the day that the Federal Reserve begins to buy Treasuries, fixed income investors, who hold everything from corporate bonds to mortgages to credit card loans, should begin to sell their holdings in a panic, which in turn will send credit spreads to new highs (new lows in prices). Fixed income prices will fall to new lows because the Fed has been helping to artificially support fixed income prices with plans such as TARP/TALF, among others. As stated earlier, there are limits to the number of problems that the Federal Reserve can attempt to fix. As the Federal Reserve begins to buckle under its bailout programs, rational investors should recognize that instead of a few programs succeeding, all plans will fail together.

The take-home message is that the Federal Reserve can only do so much to instill confidence in markets. So far the Federal Reserve has been working overtime to stabilize fixed income markets. Now that long-term Treasury bonds are falling, the Federal Reserve will be forced to bail out another borrower – the US Government. As the Federal Reserve begins to buy Treasuries, the Federal Reserve will quickly become overwhelmed by its purchases, and all US fixed income prices will fall. At that point, the only option for the Federal Reserve would be to print new money at increasingly faster rates. Likely, it will be too late because the Dollar already will have resumed its decline. Only precious metals and certain foreign currencies will preserve purchasing power as a result of the Federal Reserve’s troubled policies.

Foreign holdings of U.S. Treasury debt
China held $696 billion in U.S. Treasury debt as of Dec. 31, more than Japan’s holdings of $578 billion. Foreign holdings of U.S. Treasury debt at the end of last year totaled $3.1 trillion.

Gold’s Role During Periods Of Monetary Stress
Gold’s job is, and will always attempt to during periods of monetary stress, balance the INTERNATIONAL Balance Sheet of the USA.

Putting the Numbers Into The Equation:
$3,125,000,000,000 / 260,272,000 ounces of gold = $12,006.67 per ounce of gold.

Richard Russell (Dow Theory Letters): Amazing facts in the new world
“The true deficit of the federal government is a $65.5 trillion in total obligations. This exceeds the gross domestic product of the entire world.

“Empty houses in the US now number about 14 million or one in nine homes.

“At the forum in Davos, it was revealed the 40% of the world’s wealth has been destroyed by the financial crisis so far.

“The International Labor Organization now estimates that global unemployment in 2009 could increase to 198 million or 230 million in the worst case scenario.

“In short, the biggest bubble of them all - that the US dollar is ‘money’ - is about to pop. The US dollar is on the path to the fiat currency graveyard, and will soon get there.”

Source: Richard Russell, Dow Theory Letters, March 10, 2009.

US Mint Suspends Production of More Gold and Silver Coins
Production of United States Mint American Eagle Gold Proof and Uncirculated Coins has been temporarily suspended because of unprecedented demand for American Eagle Gold Bullion Coins. Currently, all available 22-karat gold blanks are being allocated to the American Eagle Gold Bullion Coin Program, as the United States Mint is required by Public Law 99-185 to produce these coins “in quantities sufficient to meet public demand . . . .”

The United States Mint will resume the American Eagle Gold Proof and Uncirculated Coin Programs once sufficient inventories of gold bullion blanks can be acquired to meet market demand for all three American Eagle Gold Coin products. Additionally, as a result of the recent numismatic product portfolio analysis, fractional sizes of American Eagle Gold Uncirculated Coins will no longer be produced.

Production of United States Mint American Eagle Silver Proof and Uncirculated Coins has been temporarily suspended because of unprecedented demand for American Eagle Silver Bullion Coins. Currently, all available silver bullion blanks are being allocated to the American Eagle Silver Bullion Coin Program, as the United States Mint is required by Public Law 99-61 to produce these coins “in quantities sufficient to meet public demand . . . .”

The United States Mint will resume the American Eagle Silver Proof and Uncirculated Coin Programs once sufficient inventories of silver bullion blanks can be acquired to meet market demand for all three American Eagle Silver Coin products.

Silver's discount to gold sticks out like sore thumb
In the bigger picture of the whole global economic downward spiral, silver has been a not-so-obvious victim.

"Silver is the North American ... poor-man's gold and quickly disposed of in this credit crunch," said Julian Phillips, a South Africa-based editor at "Its heavier fall is really 'investor meltdown,' not a poor market for silver as such."

History shows that the gold-to-silver ratio had been around 15 to 1 since 600 B.C. up until about the late 19th century when it climbed, according to Mark O'Byrne, director at Gold and Silver Investments Ltd.

He explains that geologically there are 15 parts of silver to every one part of gold in the earth's crust so the ratio makes logical sense. The ratio reverted back to 15 to 1 as recently as 1980, he said.

But now that ratio is more like 70 to 1.

"The discount of silver is the highest the market has seen of late," said Phillips. "I like to call it the 'long shadow' of gold for it rises further and falls further than gold all the time."

Silver may soon get the catalyst it needs.

After all, "since 80% of silver that is mined annually is as a by-product of base-metal mining, the potential supply for silver this year will be dramatically down," said Paul Mladjenovic, author of Precious Metals Investing for Dummies.

"Base-metals mining is being cancelled or curtailed due to the deteriorating world economy," he said. "With many mines closing down, that means that much less silver will come into the market [and] since investor demand for silver is still very strong, that bodes very well for silver."

"In short, I'm looking for gold to outperform in the short term and silver to outperform later on," he said.

Mladjenovic said silver has the "realistic potential" to achieve an intermediate high of about $25 by year-end and within the 2 to 3 years, "current fundamentals, from both industrial and investment demand, coupled with much lower supply, will drive the price of silver to $50." That's silver's nominal record level from 1980.

Karnani sees "an immediate-term target of $16 for silver -- $23 to $25 in the longer term, such as the end of 2009 or first quarter of 2010."

"Silver has the most sound fundamentals and will significantly outperform the precious metals and the base metals in the coming years," said O'Byrne. "It is both a safe haven and financial insurance, but also has potential for significant returns perhaps more than any commodity, currency or asset class in the world today."

Market Rallies and Rhymes: Prepare Yourself Now
Mark Twain said, “History doesn’t repeat itself, but it does rhyme.”

Right now, investors and traders are getting ready for it to rhyme again.

Earlier this week, the government felt the stock market was getting a bit too low again. Our great leaders delved into their ever-shrinking bag of tricks and pulled two of them out. In the process, they sparked the strongest rally since last summer when they stepped in.

I wouldn’t get too excited yet. If this lasts through the weekend, we’ll undoubtedly be bombarded with “that was the bottom” calls. Odds are, however, this rally will sputter out very soon – just like every other government created rally in the past.

You see, bear markets are a fickle animal. The two down days, one up day pattern can and has wrecked many portfolios.

The pattern provides the right mix for complete disaster. It provides just enough hope to keep a lot of investors hanging on. In the end, there is still a lot more down than up and the markets end up lower.

Of course, this hasn’t been your average bear market. The two days down, one day up cycle has been stretched out into five down days, one up day. But those rare up days are usually pretty big ones. Whether it’s short-covering or investors thinking “that was the bottom,” hard and fast upswings are a telltale sign we’re still in a bear market.

Quite frankly, I’m wary of this rally for a number of reasons. The number one reason is because it’s all coming from the anticipated swipe of a bureaucrat’s pen.

This isn’t a major change like rewriting the tax code to redistribute wealth from companies who “make too much money” (read: oil companies) and implementing policies which will increase everyone’s utility bills. That’s a different matter which forces, for better or worse, structural economic change.

This is a one-time deal like the stimulus package, an emergency Fed rate cut, or temporary ban on short selling. As we’ve seen time and time again during this downturn, they just don’t last.

1. January 2008 Meltdown – Everyone thought this was the BIG ONE. The world later learned it was just the start. That wasn’t going to stop the government (or technically de facto government – Federal Reserve) from stepping in with a temporary Band-Aid. The Fed made an emergency rate cut of 0.75% - the biggest one-time cut since 1984.

2. July 2008 Bank Stocks Plummeting – “The banks were ‘fine.’” It was the short sellers to blame. SEC bans short-selling on financial stocks and sends bank shares soaring…temporarily.

3. TARP Unveiled – Nobody knew what it was supposed to do, where the money was going to go, or exactly how it was going to work, and they still don’t. But it meant most of Wall Street bets would get paid. Good enough for a brief rally.

4. Obama Stimulus – Obama won! The initial idea of $787 billion spending spree unveiled. The economy will be saved. By solar and infrastructure stocks! Or so they said. As we expected, it didn’t last.

5. Uptick Rule Reinstated and Mark-to Market Rules Relaxed – Strong three day rally which eventually ???????

See a pattern?

The government is setting them up again and, if history is any indicator, there will be a time to knock them down again soon.

There is absolutely no reason not to expect this time to be different than any other time the government intervened in the markets.

That’s why, now more than ever, you’ve got to stick to your disciplines. A couple of rule changes are not going to make too much of a difference. The U.S. and world economy are in drastic need of structural change and it’s not going to be easy.


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