Fire or Ice: Inflation or Deflation!?!

Make Sure You Get This One Right
Click here for a link to ORIGINAL article:
By Niels C. Jensen | 17 July 2009 by way of John Mauldin's "Outside the Box"

Let's begin by setting the macro-economic frame for the discussion. I have been quite bearish for a while, suspecting that the growing optimism which has characterised the last few months would eventually fade again as reality began to sink in that this is no ordinary recession and that 'less bad' doesn't necessarily translate into a quick recovery. I still believe there is a good chance of enjoying one, maybe two, positive quarters later this year or early next; however, a crisis of this magnitude doesn't suddenly fade into obscurity, just because the economy no longer shrinks at an annual rate of 6-8%.

Going forward, not only will economic growth disappoint, but the economic cycles will become more volatile again (see chart 1) with several boom/bust cycles packed into the next couple of decades [[actually, I and many others see the bad times lasting only another decade— or until 2022 at the latest…: normxxx]]. This is a natural consequence of the Anglo-Saxon consumer-driven growth model having been bankrupted. Growing consumer spending over the past 30 years led to rapidly expanding service and financial sectors both of which will now contract for years to come as overcapacity forces players to downsize.

This will again lead to higher corporate earnings volatility which will almost certainly drive P/E ratios lower [[but I am looking for a bottom in the P/E cycle around 2010 or thereabouts: normxxx]], making conditions even trickier for equity investors. At the bottom of every major bear market in the last 200 years, P/E ratios have been below 10. As you can see from chart 2, few countries are there yet. The next decade is therefore not likely to be a "buy and hold" market for equity investors. The combination of low economic growth and pressure on valuations will create severe headwinds. The most likely way to make money in equities will be through more active trading.

So now, two years into this crisis, where do we stand and where do we go from here? History offers limited guidance, as we have never experienced the bursting of a bubble of this magnitude before. The closest thing is the collapse of the Japanese credit bubble around 1990. As the Japanese have since learned, recovering from a deflated credit bubble is a long and very painful affair.

Governments and central banks on both sides of the Atlantic are pursuing a strategy of buying time, hoping that a recovery in economic conditions will allow our banking industry to re-build its capital base. The Japanese pursued a similar strategy back in the early 1990s. It failed miserably and set the country back many years in its recovery effort. Ironically, the Japanese approach was almost universally condemned as hopelessly inadequate at that time. It is funny how you always know better how to fix other people's problems than your own. A little bit like raising children, I suppose.

Another lesson learned from Japan [[and the U.S., circa the '30s: normxxx]] is that once you get caught up in a deflationary spiral, it is exceedingly hard to escape from its grip. The Japanese authorities have used every trick in the book to reflate the economy over the past two decades. The results have been poor to say the least: Interest rates near zero (failed), quantitative easing (failed), public spending (failed), numerous attempts to drive down the value of the yen (failed); the list is long and makes for painful reading.

We are effectively caught in a liquidity trap. The Bank of England, the European Central Bank and the Federal Reserve have all flooded their banking system with enormous amounts of liquidity in recent months but what has happened? Instead of providing liquidity to private and corporate borrowers as the central banks would like to see, banks have taken the opportunity to repair their balance sheets. For 'quantitative easing' to be inflationary it requires that the liquidity provided to the market by the central bank is put to work, i.e. lenders must lend and borrowers must borrow. If one or the other is not playing along, then inflation will not happen.

This is illustrated in chart 3 which measures the growth in the US monetary base less the growth in M2. As you can see, the broader measure of money supply (M2) is seriously failing to keep up with the growth in the liquidity provided by the Fed. In Europe the situation is broadly similar.

There is another way of assessing the inflationary risk. If one compares the total amount of credit destruction so far (about $14 trillion in the US alone [[perhaps something more than twice that for the world as a whole: normxxx]]) to the amount spent by the Treasury and the Fed on monetization and fiscal stimulus ($2 trillion), it is obvious that there is still a sizeable gap between the capital lost and the new capital provided.

If we instead move our attention to the real economy, a similar picture emerges. One of the best leading indicators of inflation is the so-called output gap, which measures how much actual GDP is running below potential GDP (assuming full capacity utilisation). It is highly unlikely for inflation to accelerate during a period where the output gap is as high as it currently is (see chart 4). Theoretically, if you believe in a V-shaped recession, the output gap can be reduced significantly over a relatively short period of time, but that is not our central forecast for the next few years.

I can already hear some of you asking the perfectly valid question: How can you possibly suggest that deflation will prevail when commodity prices are likely to rise further as a result of seemingly endless demand from emerging economies? Won't rising energy prices ensure a healthy dose of inflation, effectively protecting us from the evils of the 'deflationary spiral' (see chart 5)?

Good question— counterintuitive answer.


Contrary to common belief, rising commodity prices can in fact be deflationary as long as demand for such commodities is relatively inelastic, which is usually the case for basic necessities such as heating oil, petrol, food, etc. The logic is the following: As commodity prices rise, money earmarked for other (less necessary) items goes towards meeting the higher commodity price and consumers are essentially forced to re-allocate their spending budget. This causes falling demand for 'discretionary' items and can in extreme cases lead to deflation. We only have to go back to summer of 2008 for the latest example of a commodity price induced deflationary cycle.

A price increase on a price inelastic commodity is effectively a tax hike. The only difference is that, in the case of the 2008 spike in energy prices, the money didn't go towards plugging holes in the public finances but was instead spent on English football clubs (well, not all of it, but I am sure you get the point) which have become the latest 'must have' amongst the super-rich in the Middle East. For all those reasons, I am becoming increasingly convinced that the ultimate outcome of this crisis will turn out to be deflation— not inflation. Inflation may eventually become a problem, but that is something to worry about several years from now. The Japanese have pursued an aggressive monetary and fiscal policy for almost 20 years now, and they are still nowhere.

So why are interest rates creeping up at the long end? Part of it is due to the sheer supply of government debt scheduled for the next few years which spooks many investors (including us) [[and also results in a short-term incapacity to digest the sudden surge: normxxx]]. And the fact that the rising supply is accompanied by deteriorating credit quality is a factor as well. But countries such as Australia and Canada, which only suffer modest fiscal deficits, have experienced rising rates as well, so it cannot be the only explanation.

Maybe the answer is to be found in the safe haven argument. When much of the world was staring into the abyss back in Q4 last year, government bonds were considered one of the few safe assets around and that drove down yields. Now, with the appetite for risk on the increase again, money is flowing out of government bonds and into riskier assets.

Perhaps there are more inflationists out there than I thought. Several high profile investors have been quite vocal recently about the inevitability of inflation. Such statements made in public by some of the industry's leading lights remind me of one of the oldest tricks in the book which I was introduced to many moons ago when I was still young and wet behind the ears. 'Get long and get loud' it is called; it is widely practised and only marginally immoral. Nevertheless, when 'famous' investors make such statements, it affects markets.

The point I really want to make is that the inflation v. deflation story is the single biggest investment story right now and being on the right side of that trade will effectively secure your investment returns for years to come. If I am wrong and inflation spikes, you want to load your portfolio with index linked government bonds (also known as TIPS for our American readers), gold and other commodities, commodity related stocks as well as property [[ie, 'hard' assets: normxxx]].

If deflation prevails, all you have to do is to look towards Japan and see what has done well over the past 20 years. Not much! You cannot even assume that bonds will do well. Recessions are bullish for long dated government bonds, but a collapse of the entire credit system is not. The reason is simple— with the bursting of the credit bubble comes drastic monetary and fiscal actions[[— whose outcomes are scarcely predictable: normxxx]]. Central banks print money and governments spend money as if there is no tomorrow, and all bets are off. Equities will do relatively poorly as will property prices. But equities will not go down in a straight line. The market will offer plenty of trading opportunities which must be taken advantage of, if you want to secure a decent return.

All in all, deflation is ugly and not conducive to attractive investment returns. It is also not what governments want and need right now. With a mountain of debt hitting the streets of Europe and America over the next few years, as the cost of fixing the credit and banking crisis is financed, one can make a strong case for rising inflation actually being the favoured outcome if you look at it from the government's point of view. The problem, as the Japanese can attest to, is that deflation is excruciatingly difficult to get rid of, once it has become entrenched. I am in no doubt which of the two evils I would prefer, but we may not have the luxury of choosing our own destiny.

Tackling Medicare And Social Security

Means Of Deficit Reduction: Tackling Medicare And Social Security

By Edward Harrison, Naked Capitalism | 15 July 2009
(Edward Harrison is the main writer at Credit Writedowns.)

Yesterday, I argued that the United States faced a policy dilemma in avoiding debt deflationary forces while maintaining fiscal prudence. The reality is that President Obama faces political constraints in Washington right now in regards to budget deficits. He is not likely to get another stimulus package through the Congress unless he can credibly demonstrate a longer-term deficit reduction outlook. In my view, this necessarily means changes to Social Security and/or Medicare.

Last June and July, I presented five charts from Ross Perot’s website perotcharts.com which demonstrate the future budgetary problem:
Chart of the day: US Federal government spending
Chart of the day: US federal spending and receipts
Chart of the day: projected US government deficit
Chart of the day: US national debt
Chart of the day: US Federal Deficit

Fiscal Year 2007: Before The Bubble Burst

What strikes you if you look at these charts is that the United States faces a very large fiscal problem under present tax and spend scenarios given likely future growth outcomes [[even before our current monetary/fiscal/economic meltdown: normxxx]]. In plain English: there is a gigantic hole in the U.S. Government’s balance sheet under normal GAAP accounting. Let’s look at the balance sheet for 2007 because John Williams at ShadowStats.com has already done the analysis and this was a budget that was created before the housing bust was apparent.

On December 17th, The U.S. Treasury released the annual Financial Statements of the United States Government for fiscal year 2007 (year-ended September 30th), prepared using generally accepted accounting principles (GAAP), audited by the General Accountability Office (GAO) and signed off on by Treasury Secretary Paulson. The statements still show that the federal government’s fiscal woes continue to careen wildly out of control. Based on my estimate of the 2007 GAAP-based deficit exceeding $4.0 trillion (see discussion below), the term "out of control" is not used loosely. If the government were to raise taxes so as to seize 100% of all wages, salaries and corporate profits, it still would be showing an annual deficit using GAAP accounting on a consistent basis.

The number $4 trillion is the number you would see if the U.S. Government reported its accounts as businesses [[are required by law to : normxxx]] do on an accrual basis using Generally Accepted Accounting Principles (GAAP). GAAP accounting means that all 'promises', i.e. future pension and healthcare spending, must be accounted for on today’s financial statement. If we did not do accounts on an accrual basis, then many companies would simply go bankrupt when those future liabilities not addressed on their current balance sheet came due. In the case of General Motors, future liabilities for pensions and healthcare are a large part of their financial problem.

The U.S. government reports its accounts on a 'cash' basis. That means it matches the cash that comes in the door against bills it must pay in that current year. This is how small businesses run their accounts. Under this methodology, the accounting looks very different. Here is how George W. Bush summed up his 2007 budget deficit (Fiscal Year 2007 Overview).

For 2007, the Budget forecasts a decline in the deficit to 2.6 percent of GDP, or $354 billion. By 2009, the deficit is projected to be cut by more than half from its projected peak to just 1.4 percent of GDP, which is well below the 40-year historical average deficit. As last year’s dramatic increase in receipts demonstrates, the most important factor in reducing the deficit is a strong economy. [[Or, at least, as in Lake Wobegon, "above average" as far as the eye can see…: normxxx]]

His last words are well-placed because we know that the course of events was quite a bit different than was predicted in this budget. In sum, there is a large hole in the government’s accounts that is an order of magnitude larger when you use GAAP. This was true even before the housing bubble and makes plain that the U.S. government’s budgetary problems are structural. (Also see Wikipedia’s entry on the 2007 Budget. It gives a good overview)

Honing In On The Problem: Medicare And Social Security

The problem, of course, is Medicare and Social Security. Looking again at 2007 and the composition of spending (Chart of the day: US federal spending and receipts), one can see that 40 percent of the budget went to spending on Medicare/Medicaid and Social Security. This percentage will rise inexorably as the Baby Boom generation begins retiring in earnest starting in 2011. If you look at the government’s own accounts (PDF), they tell the story. Notice the over $40 trillion in unfunded liabilities associated with Medicare/Medicaid and Social Security.

How This Fits In To Today’s Debate

These unfunded liabilities fit into today’s policy debate in that reducing Social Security and Medicare benefits would not only eliminate structural budgetary problems, it would also allow Obama to demonstrate fiscal prudence— even while the present deficit balloons. I guarantee you that Summers, Geithner, Orszag and Romer are on to this and that this is a debate of huge importance inside the Administration. I anticipate we will see a Social Security/Medicare change under Obama. The question is how would this change be achieved. There are four possible ways:

• Raise Taxes. To satisfy liberals, who have become more and more worried about Obama, one could see the Administration allowing Congress to eliminate the payroll tax exemption on some of the income earned above $100,000. If you listened to Joe Biden on Meet the Press on Sunday, it was clear that the President is going to make pragmatic decisions on budget issues and will not veto bills unless their totality is "wrong for America". Translation: he would not necessarily add in a payroll tax increase himself, but he would sign a bill that has one if he could tout this as a tax increase for the rich and stress the fact that the middle class would see no rise in the income tax.


• Reduce Benefits. Another way to reduce entitlement liabilities is to reduce the net benefits. Obviously raising tax on benefits for those earning a specific threshold outside income would be the taxation way of achieving net benefit reduction. Again, this would be touted as a tax on the rich. Cutting benefits outright is a non-starter and political suicide. On Meet the Press, Biden was unwilling to dismiss the potential that the President would sign a Universal Health Care bill that taxed health care benefits. I think this is a crucial statement regarding both UHC and entitlement programs.


• Reduce Coverage. Because medical care has advanced hugely over the last decades, we are now able to keep patients alive (and often healthy) who would have died years ago. As a result, medical costs have skyrocketed. The simple fact is that using all available medical science to treat patients costs a lot of money. This makes attractive the potential cut of Medicare coverage i.e. reducing which procedures and care will be paid for. I expect, this is another option that is going to be explored.


• Delay Benefits. This is my preferred option. The average lifespan of Americans has increased tremendously particularly since Social Security was enacted. As a result, retirees today receive many more benefits than they did in the 1940s. ("The 2000 U.S. census revealed that the number of Americans over 65 years old has more than doubled since 1950 and increased from 31.1 million to 34.91 million from 1990 to 2000, largely because of continuing advances in medical science and nutrition".— MSN Encarta Encyclopedia). These demographics are killing the U.S. and they are going to get worse. Given the relatively low fecundity rates among young American women, they will get worse still. Therefore, the U.S. government is going to have to raise the age at which Americans are eligible for Social Security.

In sum, while I prefer a delay of benefits, all of these ways of reducing entitlement benefits are going to be researched and suggested. The Obama Administration does seem willing to address these issues, potentially as a quid pro quo for another round of stimulus.

An Alternative View

I would be remiss if I didn’t present you with links to the other side of this argument. This is handled capably by Dean Baker of the Center for Economic and Policy Research, one of the few economists to have spotted the housing bubble early (see his 2002 article here). In April, he penned a piece at Andrew Cockburn’s site counterpunch.org called "Hands off Social Security". I suggest you read this for an alternative view. In addition, I would also recommend his book with CEPR colleague Mark Weisbrot "Social Security: The Phony Crisis."

One reason Baker is so vehement in his arguments is that he knows ideologues are orchestrating a battle against social security in order to deprive you of your retirement benefits. Remember the 2004 Bush plan to privatize Social Security? What lies underneath this is a desire to give the financial services industry far greater power and income security (for themselves, of course) by allowing it to control the funds for Social Security [[Check your latest 401K statement before answering yae or nae!: normxxx]]. So, be forewarned.

In the end, while I have great respect for Baker— and agree with many of his arguments, I disagree with his conclusions (summarized here in his opposition to the film I.O.U.S.A.). Social Security and Medicare must be changed.

Conclusion

In the end, if you are looking for ways to increase stimulus to prevent a double dip or debt deflation while remaining fiscally prudent, a cut to entitlement programs is going to be necessary. As I see it, you can’t have your cake and eat it too. [[We recently tried to do just that!: normxxx]]

For Those Bears Among Us...

Doomsville

By Neil Hume | 10 July 2009

Lest anyone was thinking of turning bullish after listing to the siren calls of Bond and Winder, we present the following counterpoint.

From an email doing the rounds in the City of London on Friday morning (The author is an MD(?) at one of the big banks):

US Housing It led us into this recession & it will likely lead us out. This asset class is the collateral spine of household & bank B/S. It remains a sine qua non for the mkt. Unfortunately, foreclosure filings are +18% yoy (May), the mort delinquency rate (9.12%) is a record, prime defaults have just doubled (yoy) to 2.9%, new and existing home sales are still barely off their Jan lows (you’d need to see a 50% increase from here to be consistent with flat gdp), unsold inventory is still at 10.2 mths (even without "shadow inventory" from banks & Securitised Mort Trusts), 30% of morts are in negative equity & % is rising/equity declining: 18.1% of house prices are still ugly….

US Consumer Too much debt, not enough credit. Declines in the housing & equity mkts have removed c$14tr from his net worth (Fed) at a time when he’s 3x the leverage of 20 yrs ago & carrying $13.5tr of debt. That process of de-leveraging is just starting. Delinquencies on Home Loans just hit 3.5% (ABI), a number that will grow in tandem with unemployment & US Personal bankruptcies (ABI) were +35% last seen. Look at the recent & salutary examples of the banks and Japan’s lost decade to remind us just how painful & prolonged the de-leveraging process can be. The savings rate just hit 6.9%. It has reverted to 10% in prev deep downturns. That cld be exacerbated by a baby boomer generation who in previous recessions cld get credit & had a higher propensity to spend (in their 30’s) but who now can’t get credit & have a greater propensity to save (as they’re now in their 50’s). The latest non-farm number (-472,000) wasn’t just worse than expectations, but was worse than the very worst print seen in either of the ‘80-’82, ‘90-’91 or ‘01-’02 downturns. Initial Jobless yesterday were better, but Continuing claims were worse (& a record high). Unemployment (beware the lagging mantra) is relevant because this is a credit related crisis & unemployment’s continued rise to & thru 10% (The Congressional budget is based on 8.1% ‘09) will generate more delinquencies & foreclosures. Moreover, the "leading" indicator components of the non-farm report— Hours worked (still at a record low & with a 70% correlation to GDP) & Temporary Hires (-37/-) are still showing falling leaves rather than green shoots. Credit cards (the lender of last resort) are seeing record charge offs (Moody’s: 10.6% vs 9.9% in Apr) & cc outstandings are falling at a 20% annualised rate with consumer credit contracting by over $50bn since Lehman hit the tape. Remember, the consumer is just starting, not just ending his de-leveraging process.

US Insiders A vote of No confidence. 51% of CEO’s (Business Roundtable) expect lower capex (the inventory replenishment is now a given for the mkt) & 49% expect lower payrolls going fwd. Directors sold $2.9bn of stock in June (Trimtabs). The Sell/Buy ratio is a monster 10x, so the green shoot callers might be selling it, but the Corp insiders aren’t buying it.

US Dividends 70% of US equity rtns since 1900 (LBS) have been generated by dividends. In Q2 just 233 S&P names raised their divi (a record low) & 250 names actually cut (2nd worst ever reading).

US Valuation Valuations are not at a level that discounts any ongoing negative news. Mkt bottomed (666) at 11.7x. The ave of of the last 11 bear mkts (where over 70% have seen a lower bottom) has been 9.9x (Haver) & there’s nothing ave about this recession. Going all the way back to 1929 (NDR) and we find that PE multiple expansion has averaged 10% in the first 3 mths & 22% in the first 6 mths of recovery. We just clocked up 40%! With the "P" already there we need the "e" to catch up real fast to validate this rally.

US Technicals & Volume Better to wear out than rust up? Dow has broken its 8300 Head & Shoulders neckline support & 200 day move ave (FTSE has broken its 4295 Triple Top neckline, 200 day & failed to breach its channel top). Dow theory: (DJT has failed to validate the main index highs) is also firmly in the bear camp. S&P has been clinging on by its fingernails but the breach below its 200 @ 887 & a subsequent fall below major support @ 875 wld frighten lots of rabbits. Ave daily vol has contracted by 30% on the S&P & c 50% on the Dow over the last 3 mths (Trimtabs). Bear mkt bottoms (19 going back to WWII) have typically been associated with steady eddy rallies on good vol (Hussman). The 4 episodes that were the exception & saw rel light vol also only rallied modestly. We’ve just belted the biggest rally since the Depression on increasingly thinner vol with just slightly less depressing news…. which reminds me of the Sage of Omaha’s axiom that "you can’t make a baby in a month by making 9 women pregnant". Light trading vol (compounded by higher vol on recent down days vs lower vol on recent up days), and a diminished response to "positive" news imply that we don’t need to see strong selling pressure to roll us over some more. Just buyer’s fatigue. And we need to beat last quarter's rate (a 62% beat rate in Q1) not just meet consensus eps forecasts for Q2.

US Issuance Today’s problem or tomorrow’s promise? May clocked up $64bn & June was similar. The prev record issuance was $38bn. There have only been 12 mths since ‘98 that Corp issuance has exceeded $30bn & the ave rtn of the S&P over the nxt qtr was btwn -4% to -7% (Trimtabs)

US Quotes (recent) Moody’s: "US housing won't hit bottom until 2010". Hayashi (Jpn Economy Minister) "The US economy has yet to hit bottom". S&P: "CMBS credit deterioration is just beginning" ($400bn of commercial property re-sets to y/e). I think this space is armed & dangerous. IMF: "The retrenching of the US consumer is a huge adjustment that the whole global economy is going to have to absorb". Buffett (who’s a bull remember) "I had a cataract op on my eye recently & I still can’t see any green shoots".

US/China Our knight in shining armour. But… The US is 25% of global gdp & China is 8%. 6% Chinese gdp grth (which we’re all now excited about) is actually still consistent with an ongoing global recession. For every 1% that the US consumer shrinks, the Chinese consumer needs to expand by 6%. Jpn shipments to China dropped -29.7% in May (-25.9% in Apr). 1/3rd of China’s gdp are exports (47% for Asia)….& those mkts are still contracting. People are talking up 'de-coupling' again, despite the fact that that particular chocolate teapot got melted before.

And finally

California, Russian banks, CMBS, Sovereign risk (Baltic states), Swine Flu….

Still bullish?

(H/T Grim Reaper).

Russia's Imploding Banks

Keep An Eye On Russia's Imploding Banks

By Ambrose Evans-Pritchard, Telegraph, UK | 2 July 2009

Russia is sinking into a swamp of bad loans. The scale of credit rot in the Russian banking system exposed by Fitch Ratings this week is truly staggering. The report is yet another cold douche to those betting that the BRICs (Brazil, Russia, India, and China) can pull us out of our mess.

Lenders will need to raise $60bn (£37bn) in fresh capital if the "pessimistic scenario" unfolds. Bad loans could reach 40%, although analysts are flying blind since bank disclosure "does not always capture all asset quality problems". Uhhm. The report follows an equally disturbing (if very different) note on the banks in China, where a "margin squeeze" has set off a explosion of unstable loan growth. Some might see as this as `good’, ie stimulatory, but since the liquidity is sloshing around a crushed economy that still lives off deflated US and EU export markets, it is largely leaking into Chinese asset speculation. [[And has produced another bubble in resource prices, which seems now to be waning as China is running out of storage facilities!: normxxx]]

This is much like the US from mid-1928 to late-1929, a strange 15 months, often forgotten. By then the world economy had tipped over. Trade was contracting. Commodity prices were deflating. Yet leveraged funds flooded Wall Street, decoupled from the underlying reality. We all know what happened. The markets buckled for no obvious reason in September 1929, then cratered in October.

As for India, excuse me, but with a combined budget deficit of 13% of GDP (including fuel subsidies, which are kept off books) and "real" interest rates of -5.5%, Delhi already has its foot to the floor. India is heading towards a debt compound trap as fast as Britain— and there is a shocker. No doubt India and China will thrive in the end, but it is wishful thinking to expect the BRICS to pull the whole global economy out of the debt-leverage dump.

But I digress. Fitch is coy about the exact meaning of a "pessimistic scenario" for Russia, but it is closely tied up with price of oil and metals. Commodities make up 80% of Russia’s exports. Crude has of course jumped back up from the February low of $30s to around $70 a barrel, but is still half its mad peak of $147 last year. Whether it will stay there is a disputed matter.

The level of "cheating" by OPEC members is creeping up again. The International Energy Agency has slashed its outlook for the next five years, saying demand in 2013 will be 3.3m barrels a day less than previously expected: a) global growth is not going to roar back, given the massive headwinds, b) a lot more has been done to raise fuel efficiency than often realized. Vladimir Putin has not yet fully understood the mess that he is in (he is not alone in that).

This week he ordered banks to step up lending, ie, to dig themselves deeper into a hole. "I am asking the heads of financial institutions to control this situation and not to plan any summer holidays until the moment that this has been dealt with as it should," he said. Even by the Kremlin’s own count, Russia’s economy will contract by 8.5% this year. Capital Economics says more like 10%, with unemployment rising to 13% by the end of next year. This is worse than the economic crunch following Russia’s default in 1998.

How far we are from the giddy heights of last summer, when Russia could imagine for a moment that it was a superpower once again, and Georgia felt the lash. It is a fair bet that Russia will weather the crisis. Some $57bn in foreign debt must be rolled over this year but that is manageable. The Kremlin still has deep pockets. ($400bn in reserves, the world’s third largest). It can and certainly will step in to prevent a systemic crisis. The biggest four banks have already received $24bn in fresh capital. There will be no state default.

But if you want to plunge into Russian equities on the ground that they are still cheap, follow the advice of Kingsmill Bond, chief strategist at the Moscow investment bank Troika Dialog.

• Avoid cash guzzlers such as Transneft and Gazprom with an attitude problem, ie, contempt for investors. The government has a strategic stake in 68% of the listed stocks.


• Stick to those with both free cash flow and eagerness to offer a decent dividend such as Sberbank, Peter Hambro Mining, Raspadskaya Coal, Baltika, TNK-BP, MTS, Uralkali, and NOVATEK.


• Do your research. "Investors are starting to call into question the fanciful nature of calculations that underpin certain company valuations," he said.


• Note a final warning from Mr Bond. The Moscow bourse tipped over a month or so before the oil price peaked in July last year. Equities were the early warning signal.


• The Moscow bourse has tipped over again, falling over 20% since the start of June. We have been warned.

Shipping Flashes Early Warning Signals Again

Shipping Flashes Early Warning Signals Again

By Ambrose Evans-Pritchard, Telegraph, UK | 13 July 2009

Port statistics are revealing. They were a leading indicator before the production collapse in the Japan, Europe, and the US over the winter, and they may be telling us something again. Amrita Sen at Barclays Capital says the number of Baltic Dry ships waiting to berth— mostly in China and Australia— has begun to fall after peaking at 154 in mid-June.

The Capesize Iron Ore Port Congestion Index (a new one for me, I must confess) is replicating the pattern seen a year ago just before the commodity boom tipped over. "The anecdotal evidence we are hearing is that vessel queues have been falling. There are reports of cancelled tonnage from China pointing to a slowdown in Chinese buying of coal and iron ore. We are definitely expecting a correction. People have been building stocks of iron ore too quickly in anticipation of the stimulus package in China," she said.

The Baltic Dry Index measuring freight rates jumped 450% in the first half of the year on the China rebound, but has begun to fall back over the last two weeks. (Sen doubts freight rates will recover much since 1000 new ships are hitting the market this year and again next year, compared to 300 in normal years. There is obviously a horrendous shipping glut). Over at Naked Capitalism they are reporting that international port traffic for containers (ie finished goods) is as dire as ever. The rates for 40-foot container from Asia and America’s West have actually fallen this year from $1,400 to $920.

"There has never been a decline like this before," said Neil Drecker from the Drewry Report. "The container industry is looking at a $20-billion black hole of losses. We can expect a lot of casualties". As readers can guess, I remain extremely sceptical of this commodity rally (although it was to be expected as part of the inventory restocking effect). It is not underpinned by real global demand.

It is [mostly] an anti-inflation play by funds betting that quantitative easing by the world’s central banks will lead to systemic currency debasement. That may ultimately happen, but the more immediate threat is the abrupt slowdown/contraction of the broad money supply (M3, adjusted M4) and the collapse in the velocity of money, as well a post-War low in capacity use (68% in the US), and a massive global "output gap".

All the deeper signs suggest to me that action by the Fed, Bank of Japan, Bank of England, and the European Central Bank is still not enough to offset the deflation shock. Though I recognize that this is a deeply unpopular view these days in the blogosphere. Deutsche Bank has told clients to tread carefully. It says the global output gap is -6%, and it is this gap— not the level of economic growth as such— that drives oil prices over the long run. We have in any case seen a $10 dive in oil prices already as the doubts creep in of the global recovery.

Note that Deutsche Bank’s China team says the Chinese economy is "close to the cusp of the second down leg of a forecast `W’ on the back of tightening lending and slowing stimulus spending," according to the bank’s latest report "Still Wary of Global Cyclicals". We are all longing to be bulls again, but we (Mankind, that is, especially the West) have a long hard slog ahead to work off our debt depravities.

Lenders Abandoning Foreclosed Properties

Lenders Abandoning Foreclosed Properties
‘walkaway’ Properties Quickly Deteriorate, Dragging Down Borrowers And Neighborhoods

By Cary Spivak, The (Milwaukee) Journal Sentinel | 11 July 2009

Alton Lewis wants to see the abandoned house next to his home torn down. An order by the City of Milwaukee to raze the building was issued in November 2008 but the building still stands.

Rodney Lass surveys the house on E. Lincoln Ave. that he thought he had lost to foreclosure last year. The mortgage administrator that sought to foreclose on the property gave up on the effort, however, and Lass remains the owner.

Rodney Lass figured his days as a homeowner were over when he was hit with a foreclosure judgment more than a year ago. He stopped rehabbing his two-story Bay View home and moved on. But what Lass didn't realize until recently is that the house remains in his name today. He's still responsible for the taxes, upkeep of the property and the mortgage, leaving Lass perplexed.

"Why would I pay for something that I don't own anymore?" Lass said. The foreclosure, however, failed to go through after the California-based lender decided it didn't want the gutted house. Lass said he found out for certain that he still owned it from the Journal Sentinel. Today, the house at 703 E. Lincoln Ave. sits condemned, holes in its roof, a blight on the working-class neighborhood.

The home represents a growing phenomenon known as walkaways— properties for which lenders sue for foreclosure but never take the title. For years, lenders complained about debtors who left the keys on the kitchen table and skipped town, leaving it to the bank to file for foreclosure and eventually take title by buying it at a sheriff's sale. The latest twist: Now it's the lenders who are doing the walking, often without telling the borrowers, who may believe erroneously they have already lost title.

"This is just the meanest and nastiest thing (lenders) could do," said Catherine Doyle, chief staff attorney at the Milwaukee Legal Aid Society. "Even more profound is the terrible damage to the community. All of us are going to have to bail them out". City officials, lawyers and community activists say they've seen an increase in lender walkaways, although they can't estimate how large the problem is.

The Journal Sentinel found more than $400,000 in back taxes, fees and demolition costs owed on nearly three dozen properties that lenders foreclosed on in the past two years but didn't complete the process. Three more have been condemned and are scheduled to be bulldozed at an estimated cost of up to $15,000 each.

The Journal Sentinel calculated the amount owed in taxes for walkaways, or orphaned properties, by comparing a database of foreclosed Milwaukee County properties that were not sold at sheriff's sales to properties being foreclosed by the city. Milwaukee begins foreclosure proceedings— which are separate from the proceedings brought by lenders— when the property has at least three years of delinquent taxes.

"I don't like hearing about money owed to the city at a time when the city is strapped financially," Mayor Tom Barrett said. "That's a concern. That's a huge concern."

This Is Just Madness

Cities throughout the country are seeing an increasing number of walkaway properties, said Kathleen Day of the Center for Responsible Lending. She said she knew of no other attempt to quantify the extent of the problem or its impact on a city. "We hear about it anecdotally all the time here— all the time," Day said. "This is just madness. There has got to be some better way."

The seeds for the growth in orphaned properties were planted in the years before the housing bubble burst— back when buyers, sellers and lenders all acted as if prices could only go up. Mortgages were readily available to all. Subprime loans were doled out to borrowers with questionable financial track records or those who could not, or would not, document their income. The mortgages were packaged as securities and sold to investors across the globe.

In 2007, Americans owed $1.3 trillion in subprime mortgages— a nearly 300% increase over just four years earlier. As many as half of all subprime loans were given to borrowers with no more than limited documentation of their income, according to the Center for Responsible Lending. At the end of March this year, a record 12% of all U.S. mortgages were delinquent or in foreclosure, according to a Mortgage Bankers Association survey. Nearly 9% of the mortgages in Wisconsin were in foreclosure or delinquent.

Matters can get particularly complex if a borrower dies and heirs do not want the house. "It's just out there; nobody owns it," said Janet Resnick, a probate lawyer with 21 years of experience. Case in point: the vacant, boarded-up two-story house at 2721 N. 26th St., which for years had been owned and rented out by Rosella Chambers.

In 2006, Chambers refinanced the 100-year-old frame house for the second time in four years. She received a $68,800 adjustable-rate mortgage through BWM Mortgage, a now-defunct Wauwatosa mortgage banker. The loan was for nearly $30,000 more than the property's assessed value.

On May 20, 2008, Minneapolis-based U.S. Bank sued her for foreclosure. The bank had no interest in the mortgage— it was merely the trustee for an investor group that owned the mortgage. U.S. Bank had been instructed to sue by Pennsylvania-based GMAC Financial Services, which serviced the mortgage for the investor group. GMAC services about 2.7 million mortgages with a balance of $386.3 billion.

A foreclosure judgment was issued in Milwaukee County Circuit Court in August but vacated, at the lender's request, on Oct. 22— less than two weeks after Chambers died following a long illness. Chambers' daughter, Dianna Myles, said she was offered the property but did not want it. Myles said the house needed work even while her mother was alive, and since her death it had been stripped of all valuables and vandalized.

The city boarded up the house this year and began its own foreclosure proceedings for back taxes. "There is no property owner," Myles said. There are, however, unpaid bills owed to the city. Unpaid property taxes and fees total $15,280. An additional $995 is owed for boarding-up costs and cleaning up litter around the property.

Decision-Makers Far Away

Typically, the decision on whether to continue a foreclosure action is made by the out-of-state loan servicing company hired to manage billions of dollars worth of mortgages. "There's still this stereotype that we're dealing with the banker from 'It's a Wonderful Life,' " Barrett said. "We're not."

Local housing officials and real estate agents who deal with foreclosed and abandoned properties say out-of-state lenders don't know the condition of a property when the foreclosure process starts. By the time their representative checks out the property, it already may have sat vacant for months, making it a target for vandals, squatters and Wisconsin's harsh winters.

"The pipes will burst and the city fines my clients and it's a real freakin' mess and nobody is sure who has what rights," said Michael Watton, a bankruptcy lawyer who said he tells his clients to stay in a house until the legal processes are concluded. Loan-servicing companies argue they have a fiduciary duty to the investors who bought the mortgage, not to the neighborhood where the home is located.

"We do the cost-benefit analysis (for) the investor," said Jeannine Bruin, GMAC's executive director of mortgage communication. "Is he going to recoup any money for us to go through the whole process of foreclosing, fixing the property up, marketing it, selling it? Is anything coming back to that investor? If not, it's best to just let the borrower keep ownership of the home."

But by then, the borrower may think he or she has lost the title and has left. In that scenario, the neighborhoods and taxpayers may lose, say city officials and neighborhood activists. "The debtor is gone, the lender is gone and here, Mr. Mayor, you've got this attractive nuisance in your neighborhood," Barrett said. "Then I get a call from my fire department, and they're telling me we've got too many homes that are attractive nuisances, as they say, for arson or prostitution or drug trafficking. The current situation is a lose, lose, lose situation."

Unless the mortgage debt is discharged in court, the debtor may still be on the hook for the loan even though the property is vacant. According to Joyce Biearman, communications manager at Home Loan Services Inc., a Bank of America subsidiary, "We have a responsibility to make every effort to hold these borrowers responsible for any payments they agreed to make."

John Pawasaret, director of University of Wisconsin-Milwaukee's Employment & Training Institute, said lenders should shoulder some responsibility since many loans, especially subprime mortgages written on central-city properties, were based on inflated valuations. Many of the loans were known as "liar's loans" because borrowers were not required to document their income on loan applications. [[But it's usually not the lenders who sold those loans— rather, it's those "loan originators" and their brokers, who are long gone!: normxxx]]

The loan values often "had no relationship to the actual value of the house because of all these liar loans," said Pawasaret, who has studied the impact of foreclosures on Milwaukee neighborhoods. Bruin, however, said many of the loans in foreclosure today were prime loans written to borrowers who have since hit hard times and saw the values of their properties decline with the overall housing market. She said GMAC may be willing to renegotiate loans with borrowers when they hit troubles.

"It's a sticky situation, no doubt about it," Bruin said. "But I wouldn't go on record saying the lender is responsible for all of these properties in limbo". Left to deal with the fallout are individuals like Alton Lewis.

They Took Everything

Lewis and his wife, Theresa, raised seven children in the modest home on W. Clarke St. where they've lived since 1967. Today, their house sits next to a large green monstrosity at 2013 W. Clarke St. The front porch is sagging; there are gaping holes in the roof; every second- and third-floor window is shattered or missing; and the siding on much of the back of the house is gone, leaving the wood frame exposed. Their son James said he witnessed vandals stealing from the property in broad daylight.

"They took everything," James Lewis said. "I saw guys walking out with sinks and pipes". Squatters lived in the house for much of the two years that it's been vacant, said Alton Lewis. "Not only is it an eyesore, but it's dangerous," said Lewis, 72, whose 69-year-old wife is bedridden. "If that house catches fire at night… I can't get her out of (here) myself. We both could burn in there. It's bad, it's just unreal."

Some of the siding on the west side of Lewis' home is melted from a fire at the abandoned house on Feb. 23, 2008. There was also a small fire in his neighbor's garbage-strewn backyard in September 2007. Although a demolition order was issued last year, the building is still standing. It is one of about 80 houses waiting for funding so they could be razed.

Lewis has urged city officials to bulldoze the house and to tell him who owns it. "They keep telling me some lady," Lewis said. "They say some lady owns it, and they can't get in touch with her". County records show Latoya Wesley bought the house in 2006 with a subprime mortgage loan. It was one of five properties the Milwaukee woman bought around that time.

Wesley has been hit with repeated foreclosure suits and was on the way to losing title to the Clarke St. property when a foreclosure judgment was issued on Feb. 26, 2007. The property was never sold at a sheriff's sale, however. Just last month, the foreclosure judgment was dismissed.

Wesley said she isn't the owner. "It was foreclosed on," she said. "The bank owns it". Today, taxpayers are footing the costs for the house, which is being foreclosed on by the city. Wesley owes more than $18,000 in back taxes and fees, city records state. The taxpayer's tab is expected to increase by about $10,000 to $15,000 when the condemned house is demolished.

Living With An Eyesore

In Bay View, Linda Yancey and Alan Wood expressed their frustrations with living less than an arm's length from a boarded-up eyesore— the house Lass owns. Yancey and Wood originally thought of Lass as a good neighbor intent on improving a house that had a history of problems. Today, sitting in their neatly landscaped backyard, sipping a couple of cans of Milwaukee's Best beer, they look at the house with a measure of disgust.

"I've paid taxes here for 6 1/2 years. It's ridiculous that I have to live next to that," Yancey said, motioning to the boarded-up house that has been home to squatters and scores of animals. "Nobody knows what goes into that building". Like Lewis, Yancey said she has called City Hall to get the building torn down or to at least find out if Lass is still the owner. "When you call, it's like there's no answer," she said. "Is it the mortgage company or is it a 'somebody' who owns it?"

The 39-year-old Lass bought the Lincoln Ave. house in June 2006— about a year and a half after his release from prison, where he had spent about a dozen years for drug dealing. Lass financed the purchase with a $112,500 loan from subprime lending giant Argent Mortgage Co., of California. The mortgage carried an adjustable interest rate between 10.05% and 16.05%. The house quickly became a money pit. It sprung a gas leak so severe the odor could be smelled throughout the neighborhood. A broken water pipe severely damaged the interior. Tenants weren't paying rent.

In March 2008, German-based Deutsche Bank sued Lass for foreclosure. The bank was acting as a trustee for investors who had bought the mortgage. Judge Timothy Dugan issued the foreclosure judgment in May 2008, the same month the city opened a condemnation file on the property. "I didn't even go to the (foreclosure) hearing," Lass said. "I was like, 'You know what, take the house.' I felt terrible."

In September, the house was auctioned off at a sheriff's sale, with the lender making the highest bid of $108,000. It is common for lenders to buy properties at sheriff's auction. But the sheriff's deed was never brought back to Dugan for confirmation, meaning Lass remained on the title. "They own it right up to the time the judge signs the order confirming the sheriff's sale," Dugan said.

Lass said he received a letter from Dugan two months ago telling him the lender was seeking to dismiss the March 2008 foreclosure order. That was Lass' first clue that he was still a homeowner. Even then, he said, he wasn't convinced the house was his. The foreclosure action has not been completed because repossessing and selling the property "would have not provided enough money to repay any of the outstanding loans and would have only deepened losses," according to a statement from Citigroup Inc., which had serviced Lass' loan.

City records show Lass' delinquent tab to the city: $4,388 for 2008 taxes plus $865 in board-up costs. There is a raze order on the property. Dugan said the letter to Lass was probably the first time he notified a borrower that a lender was seeking to vacate a foreclosure order. Doyle of Legal Aid has been urging judges to have borrowers notified before a foreclosure order is dropped and to insist that lenders state a reason when they ask for a dismissal.

Several judges say they are doing so, but they point out that they can't force a lender to complete a foreclosure because it may be in the best interest of the community. Dugan recently denied the motion to dismiss the foreclosure in Lass' case, but that doesn't take Lass' name off the title. "I don't deal with the moral obligations," Dugan said. "I'm on the legal side."

Officials acknowledge they can do little to stop lenders and homeowners from abandoning properties. City officials hope a new ordinance requiring lenders to regularly inspect properties in foreclosure and to notify the city when one becomes abandoned will help them keep tabs on walkaways. Lass and Wesley are not the only property owners who say they did not know they still held titles.

Building inspectors, bankruptcy lawyers and other officials say they frequently hear the claim. "It's a common thing for people to say, 'I'm being foreclosed on— goodbye,' " said Jay Unora, an assistant city attorney who prosecutes building-code violations. "These people are winding up with a lot of headaches."

See also: In 'Foreclosure Limbo'

Idling Ships Clog Up Singapore Shores

Idling Ships Clog Up Singapore Shores

By Pauline Mason,BBC World | 12 July 2009

From the top of Singapore's Equinox bar you can see the city skyline and ship after ship after ship. Singapore claims to be the busiest port in the world. About 130,000 ships arrive there each year. But these days, the problem is many of those vessels are not putting back out to sea.

The usual stay for a cargo carrier is just ten days. That is enough time to offload one set of cargo and take on another load, re-fuel and re-stock supplies. But, of the 220 container ships arriving in Singapore this year,— excluding the tugs, yachts and bunkering vessels which are permanent port residents— more than half have stayed longer than that. Another 44 cargo ships have been in port for more than six months.

Time Is Money

It costs about $1,000 (£614) per day to keep a ship at Singapore port. On top of that, most of these ships would have been bought with multi-million dollar loans that need to be serviced. They will have a crew that needs to be paid, fed and watered.

Engines and machinery that need to be maintained. All of this is necessary for a ship to maintain its class— the equivalent of an MOT or bill of health. Being taken "out of class" means a ship cannot trade or earn money and cannot be insured for voyage on the open sea.

Staying Afloat

The sharp downturn in world trade is behind this enforced idleness. And, in the absence of global economic recovery, all firms can do is minimise their costs. A ship owner can save up to 80% of his or her running costs just by laying anchor 45 minutes south of Singapore, off the Indonesia islands of Batam-Rempang-Galang. Earlier this year, Rob Wilkins, general manager, Enviro Force, opened a new anchorage off Galang.

"In Singapore you have to maintain a full crew (25-30 people on average) on-board your vessel," he says. "In Batam you don't. You can save on insurance costs, maintenance costs and crew costs by laying up here instead."

Laying Anchor

Mr Wilkins and his partner Damian Chapman are 'serial entrepreneurs'. Many ships are stored outside Singapore for cost reasons. For months, they have noticed more and more vessels idling in ports, running up huge costs. According to AXS Alphaliner, 511 container ships are laid up. That is a tenth of the global fleet.

"Laying up" is the term for taking a ship out of service. There are different levels: hot stacking requires the engines to be fired up every day, allowing a vessel to be brought back into service in days; but a vessel kept in cold stack can be welded closed with engines off for months at a time. At the most extreme end, ship owners can take the ship 'out of class' and save hundreds of thousands of dollars in insurance costs alone.

Treading Water

But, these latter are drastic measures. Ship owners have a range of options before they 'lay-up' their vessels. The most common is idling your vessel beyond the port perimeters. On the ferry between Batam and Singapore, Damian points out ships that have been left anchored for months.

They don't pay port dues which saves them money but also means they don't have access to port services. One Singaporean shipmaster (who wants to remain unnamed) brags business is booming since he turned his two small service ships over to water supplies. Crew on these idling vessels are not allowed to go ashore for food or water.

Sink Or Swim

A rusting oil tanker also sits outside Singapore limits. Damian says it is being used for storage. "When the oil price was low, it was worth buying up crude and holding onto it until the price rose," he says. "That tanker will probably be sold for scrap… as soon as scrap metal prices recover."

And that's a big problem. Even for those owners who want to cut their losses and sell out, the market is grim. Jonathan Le Feuvre, managing director of shipping services firm Fearnleys Asia, says "scrap metal prices are down 75% from their peak a year ago". "And," he adds, "there are no trading buyers" who would buy the ship as a going concern.

Only those who have to sell, perhaps forced by their bank, would sell up at such low prices. Mr Le Feuvre recites anecdotes of Chinese and Greek shipping owners who have snapped up bargains at a 90% discount from the peak. There is, however, some sign of hope on the horizon: China. "It's the only game in town," according to Mr Le Feuvre.

Anchors Aweigh

"[China] is single-handedly lifting the dry sector (trade in coal, metal ores and other raw materials) out of recession," he says. "Ten months ago, owners of Capesize bulk carriers (ships carrying 150,000-170,000 dead weight tonnage used for the transport of, say, iron ore and coal) were effectively transporting cargo for free at charter rates of $5,000 a day." On 8 July, rates hit $67,000 a day.

Eye Of The Storm

But, many question whether this recovery in the dry sector can be sustained. Owners of smaller container ships used to transport consumer goods such as cars, televisions and refrigerators say business remains slow. There is still little sign people in the United States and Europe are returning to shops to buy these shipped goods.

And dismal US jobs data suggests economic recovery will take longer than hoped. AXS Alphaliner predicts a quarter of the container fleet will be idle by the end of next year. "Things will look pretty rosy in containers about 18 months from now' time," says Mr Le Feuvre, "but we're going to go through a year and a half of hell to get there." [[Or more.: normxxx]]