Cheapest Plays In Emerging Markets

The Four Cheapest Plays In Emerging Markets
An Interview With Arjun Divecha: Choosing The Right Emerging Market.

By Lawrence C. Strauss, Barron's | 27 July 2009

After going through a horrible stretch in 2008, emerging stock markets have snapped back. The MSCI Emerging Markets Index is up about 36% this year, powered by equities in China and India, among others. So what's a good way for equity investors to play these markets, which can be tricky and volatile? "The main thing in emerging markets is that getting the country right matters more than anything else".— Arjun Divecha For some perspective, Barron's last week spoke with Arjun Divecha, portfolio manager of the Berkeley, Calif.-based GMO emerging-markets equities group. He has worked for the institutional asset manager since 1993, overseeing $13 billion in assets. Divecha, 53, estimates that his value-investing approach is roughly 80% quantitative and 20% fundamental. One of the funds he oversees is GMO Emerging Markets III (ticker:GMOEX), whose minimum investment is $50 million. Its 10-year annual return of 11.43% bests nearly 90% of its Morningstar peers. Among the countries sporting the cheapest valuations are Turkey and Russia, Divecha says— but he is underweight China. To find out why, read on.

Barron's: Let's start with your macro view of the emerging markets.

Divecha: I look at countries around the world as a spectrum. At one end are the countries for whom this is a secular crisis, such as the U.S., the U.K. and Spain, where there are going to be massive changes in the financial sector, and maybe in other parts of the economy, due to the current crisis. On the other end of the spectrum are a lot of emerging markets for whom this is really a very bad cyclical crisis, as opposed to a structural crisis. So the emerging markets got hit badly last year for two reasons, one being their dependence on exports. No. 2, a lot of them had become reliant on cheap foreign capital, which came out of the credit boom.

Just how much have emerging markets decoupled from developed markets?

I think of each of these emerging-market countries as being like a boat with two engines, one for exports and the other for domestic consumption. So when people talk about decoupling, they need to think about each of these separately. Clearly, the export engine cannot decouple. But the second part, the domestic-consumption engine, has been stimulated, and the stimulus in a lot of these countries has worked exactly as you would expect it to work. Consumers, because they were not overleveraged, can in fact borrow. So in places like Brazil, where interest rates have come down from 15% to around 9½%, car sales hit an all-time record.

What's driving these changes in Brazil and other markets?

There is a massive amount of latent demand in Brazil from people who love to buy cars. What has kept them from doing it has been, effectively, the cost of ownership. So the stimulus, a combination of an increase in government spending and lower interest rates, is actually working the way that you would expect it to.

The other thing that has changed in the past 10 or 15 years has been the demographics; there are a lot more younger people in the workforce now. And as a result, the savings rates in most of these countries have gone up quite a lot. So in India, for example, the savings rate 10 or 15 years ago was 8% or 10% of gross domestic product; today, it is over 30%.

…Which contrasts markedly with the U.S. and Europe, where the populations are aging?

That's correct. But it is more important for these countries, because they need to invest. In order to develop, India needs investment. So 10 years ago, it would have had to rely on foreign capital. Today, with a 30%-plus savings rate, India is not as reliant on foreign capital as it was.

What are some of the major changes you've seen in emerging-markets investing over your career?

The main thing in emerging markets is that getting the country right matters more than anything else. If you can pick sectors and stocks in the developed markets, that is what really matters. But in emerging markets, if you don't get the country right, it becomes much, much harder to add value.

In what countries do you see the best opportunities?

The countries that we are most positive on are actually ones we think will have the biggest recovery from the bottom. Our favorite four are Turkey, Russia, South Korea and Thailand. Some of our less favorite countries where we are underweight are China, South Africa and India. China and India have recovered a lot. Their stock markets have gone up a lot this year, and are much more expensive than other markets. And given that we are primarily value investors, we look for cheapest above everything else. Countries like Turkey and Russia are very cheap in terms of stock valuations.

When we spoke earlier this month, you mentioned that you were bullish on China short term, but much less so over the long term. Is that still the case?

I've changed my mind since we last spoke. We are negative on China short term as well. The reason is that the stimulus package there has been absolutely massive. As a percentage of GDP, it is three or four times the size of the U.S. stimulus. In this year alone, they've had new loans worth over $1 trillion, of which more than $250 billion was issued in June. It is massive.

What's your biggest concern about that?

I believe that a lot of this money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which, remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.

We know that they are buying real estate, and they are doing all kinds of things that we don't think in the long run is particularly productive investment. Now, in the short run, the stimulus works, because it puts money in the hands of people who are buying and consuming stuff. So therefore, car sales in China hit an all-time record last month.

What will be the consequences in China?

Two things are likely to happen. First, longer term, if the banks don't have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short-term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on money. I don't know when that will be. But I worry that it is coming.

A fair amount of the stimulus money has found its way into the real-estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.

What gives you pause about Brazil, which isn't at the top of your list?

It doesn't give us a lot of pause, and we are not negative on Brazil. It is just that other countries have become much cheaper. We still like the story there. We still think that the government has a lot of room to stimulate in Brazil, because interest rates at 9½% are still very, very high relative to inflation, which is about 2½%. So the ability to stimulate, if they need to, is absolutely massive.

Which emerging markets are you avoiding?

We are very wary about Eastern Europe, which, in many ways, resembles Asia during the crisis of '97. A lot of the Eastern European countries have too much debt denominated in foreign currencies. So if you have a problem with the currency, which they have, your debt suddenly balloons— because you have to pay it off in the foreign currency. [He's neutral on South Africa in part because of worries about its current-account deficit.]

Why is Turkey one of your top countries? Does it's not being in the European Union hinder its prospects at all?

I don't think anybody expects that is going to happen any time soon, although it may happen in 20 years. But quite frankly, they already have what I consider to be the most important part of access to the EU. They have a customs union, which basically allows them to ship exports with a zero tax rate.

What specifically do you like about the country's prospects?

Primarily, the Turkish stock market is as cheap as we have ever seen it, trading at seven or eight times forward earnings. We have increased our exposure to the banks there, because they tend to be the most highly leveraged part of the economy. So if the economy is going to recover, the banks tend to do the best in that kind of a scenario. And in most emerging markets, you don't have banks that lent too much money— whereas in the U.S. and the developed markets, one should be wary about the banks.

Is there anything else in particular that recommends Turkey as an investment opportunity?

At the end of the day, cheapness is what matters more. What you pay for something is the most important thing of all. If you can buy something really, really cheap, you are going to make more money on that than buying something that is really good. So Turkey is pretty well-positioned, because No. 1, unlike a lot of other countries, they are used to having crises. They have crises with great regularity. So they know how to get out of crises very well. And they definitely have done a pretty good job of being very competitive in various sectors like textiles, machinery, and auto parts.

Turning to Russia, one of the biggest concerns about investing there is corruption. What's your read on that country?

Everything that everybody says about Russia is true— that the corruption problems are really terrible. But at the end of the day, when you really get down to it, Russia is an oil play. It is really an energy play. And then really, it's about: What are you paying for that energy?

To give you a comparison, ExxonMobil (XOM) has a market value of about $345 billion, versus about $40 billion for Lukoil (LKOH.Russia). One of my favorite sayings is that you make more money when things go from truly awful to merely bad than when they go from good to great. Russia is [a place] where the situation is not particularly good. The economy is actually in pretty bad shape right now. But it is a question of being able to buy at a very, very low valuation, in this case six or seven times forward earnings.

Why do you think South Korea is a good investment opportunity?

Again, valuation is very cheap, under 10 times earnings. The most interesting thing about Korea is that the won has fallen 43% from its peak against the yen, and it has fallen 36% against the Chinese yuan. So relative to the two biggest competitors they have for exports, their currency has fallen massively, improving their competitiveness dramatically. As soon as you get any kind of a recovery in global exports, the Koreans are very well placed.

What about Thailand?

It's very, very cheap, trading at less than 10 times earnings. Part of the reason why Thailand is so cheap is because the politics there have been really quite awful for the last couple of years. You had the coup, among other turmoil. Our reading is that the politics is getting better, although I don't think it is reflected in the stock market.

How do the prospects for emerging markets look?

Longer term, we are quite bullish. The only issue is that we've had such a huge rally in the last four or five months. And one has to worry about a pullback, although I'm not predicting one. Still, I'm pretty sure that you are going to get good growth out of a lot of these countries. It is hard to make that case for a lot of the developed markets. It may happen, but the case is easier to make for emerging markets.

What are your biggest concerns about the emerging markets?

Things like protectionism coming out of the West. If the crisis was to get worse in the U.S. and in the developed markets, and that brought about a legislative or governmental response for greater protectionism and you start some kind of a trade war, that would clearly be very bad for emerging markets. And it certainly would be worse for the emerging markets than the developed markets.

Thanks, Arjun.

China's Hidden Debt Problem

China's Hidden Debt Problem
Despite Robust Growth, The World's Third Largest Economy Is Potentially Deeper In Debt Than Originally Thought.

by CNNMoney

BEIJING (Reuters)— On the surface, China presents a fiscal study in contrast with the United States, keeping a remarkably low ceiling on debt even as it spends its way out of the financial crisis. But when Chinese leaders meet their U.S. counterparts this week, they should pause for reflection before venting any criticism, because hidden liabilities mean China's books are uglier— potentially much uglier— than at first sight. Thanks to successive years of fast economic growth and even faster government revenue growth, the official debt-to-GDP ratio was 17.7% at the end of last year, far lower than almost any other major economy.

The trouble is that that excludes local government borrowing, the current surge in loans backstopped by Beijing, and bad assets cleared from the banking system but still floating about. When all are thrown into the pot, analysts estimate that China's debt may be closer to 60% of GDP, putting it in virtually the same league as the United States, which was at 70% at the end of 2008 before it launched its massive economic stimulus program.

To be sure, Washington is now set on a path of exploding debt that Beijing will largely avoid. The United States budgeted for a federal deficit of 12.9% of GDP this year, whereas China is aiming for just 2.9%. But China's finances are deteriorating more quickly than the government expected, fueling a rise in the stock of both explicit and disguised debt that will constrict its wriggle room. "It is serious because, one, much of it is hidden and, two, local governments are currently doubling down on their bets," said Stephen Green, economist at Standard Chartered Bank in Shanghai. "As with all fiscal deficits, it limits space for further stimulus."

This is probably a moot point, for now. With China's economy back on track and private-sector investment kicking in, few think Beijing will need to ramp up spending beyond its existing 4 trillion yuan ($585 billion), two-year stimulus plan. But the narrowing of options still discomfits Chinese leaders. "Our fiscal work is very grim," Chinese Premier Wen Jiabao told officials last week.

Eroding Finances

Government revenues declined 2.4% in the first half compared to a year earlier, well shy of the official goal of an 8% rise. Expenditures were ahead of target and set to surge in the second half on the back of infrastructure projects. Tax intakes are, of course, closely tied to economic activity, so China's upturn should deliver cash to government coffers. But improvement in June came mainly from land sales, a one-off revenue source that masks the difficult road ahead.

"Even when we are already factoring in relatively optimistic revenue growth due to the economic recovery, the deficit is quite sticky at around 5% per year for the next three years," said Isaac Meng, economist at BNP Paribas in Beijing. But the real worry is the thickening morass of indirect debt. Officials at the Ministry of Finance estimated earlier this year that local government debt already topped 4 trillion yuan, or 16.5% of GDP, much more than previously assumed.

Above and beyond that are 400 billion yuan in bad loans in banks' hands and at least 1 trillion yuan in non-performing debt hived off their books and assigned to 'asset management' companies. The buck stops with Beijing on all of these. The record surge in bank lending this year means that its sum of liabilities is about to swell in size.

Banks have showered money on infrastructure projects that are seen as having iron-clad government guarantees. Green said he "conservatively" estimates that Beijing's bill for covering loans issued this year alone will be 1.75 trillion yuan, enough to push its 2009 deficit to 10% of GDP.

"Debt bomb"

Most troublesome of all is the potential for a "debt bomb", in the words of China's Economic Observer newspaper, at lower levels of government as those officials engage in 'financial engineering' that is both opaque and highly leveraged. Rules prevent Chinese banks from lending to governments the equity capital which they need in order to obtain further loans for investment. But local officials and banks are now exploiting a vast loophole thanks to intermediaries known as 'trust' companies.

The process is simple enough. Trusts create specially designed "wealth products", which banks sell to their clients. Banks then give the funds to the trusts and they, in turn, funnel them to governments as equity capital.

Local authorities, in short, are piling debt on top of debt. The Chinese banking regulator has started to warn trusts and banks of the growing risks, state media recently reported. It was not long ago that bad loans in China's banking system seemed to pose a massive debt threat to the wider economy. The core solution over the past decade was sustained double-digit growth, vastly expanding the denominator in debt-to-GDP ratios and generating the taxes to pay down the numerator.

Beijing is already looking to raise taxes where it can— increasing the levy on cigarettes, for example— but a return to super-charged growth is again its principal debt reduction plan. In the meantime, China needs to fund its rising deficit. On that front, at least, the government can be supremely confident, even if it has to issue more than the planned 950 billion yuan in bonds this year and yet more to cover shortfalls in coming years.

"There is so much saving and so much liquidity, so there is definitely not a problem that China will not be able to finance its deficit," said Tao Wang, UBS economist in Beijing.

Iceland's Krona Proves A Magic Wand

Iceland's Krona Proves A Magic Wand As Europe Ails

By Ambrose Evans-Pritchard | 31 July 2009

Iceland's krona is working its magic cure. Well-heeled Japanese tourists— once a rarity— can be seen these days sampling halibut at Reykjavik's Siggi Hall, or buying Gymur jackets at the 66°North store on Bankastraeti. The krona has fallen by half against the euro since the `New Viking' trio of Landsbanki, Glitnir, and Kaupthing strayed out of their depth and brought down Iceland's financial system. Nothing is cheap, but prices have come within reach. Reykjavik's cafés are packed with euro-youth, at last able to afford a taste of all-night dancing at this Arctic Ibiza.

Out in Iceland's Eastern fjords meanwhile, Alcoa has raised aluminium production to record levels— and metal matters as much as fish for exports. "The smelters are running full speed," said the new-broom finance minister, Steingrimur Sigfusson. So is Mr Sigfusson himself. Last week he launched three new banks on the ruins of the old. Normality is returning. "We are going to get through this better than feared. We're feeling real activity in the economy, and much of this comes from a favourable exchange rate," said Mr Sigfusson.

Iceland's great lurch towards casino capitalism over the last decade has a cultural logic. "We are a fishing culture: when the herring is there, we take it," said Andri Snaer Magnason, author of `Dreamland: A Self-Help Manual for a Frightened Nation'. There was no easier catch on offer than the Greenspan bubble (2000-2007) and the global "carry trade". How could fishermen resist?

In one sense it was a terrifying shock for the 310,000 inhabitants of this Norse-Celtic outpost of lava rock to see their currency, banks, and global image crash in a single week last autumn. Yet nothing has really changed. "Everything still feels normal. The services of the state are intact. The swimming pool is open. You can still have a decent heart attack in Iceland," said Mr Magnason.

"Friends who lost jobs in banking have already found new work, and you could say the [fall of the] krona has worked as a buffer for us. We all went down together, and that has led to healthier recession without mass unemployment." The jobless rate has risen to 9.1%. This is below the eurozone average of 9.5%, and is stabilising much earlier.

Those who point to Iceland as a scarecrow exhibit of what happens to a small country caught in a financial storm without the shield of euro membership have the matter backwards, as will become ever clearer over the next two years. The OECD expects Iceland's economy to shrink 7% this year. This is much better than Ireland at minus 9.8%, and recovery will come sooner. So next time you hear the Sacra Congregatio of the euro faith incant yet again that 'EMU saved Ireland' from a terrible fate, know that they deceive only themselves.

You take your punishment early with devaluation, as Britain did on leaving Gold in 1931, or ending the D-mark torture in 1992, or now. You look a sorry sight at first, but sweet vindication comes later. It is those caught in a deflation trap with fixed exchange rates that face slow asphyxiation, and deeper social damage. Youth unemployment is already 34% in Spain, 28% in Latvia, 25% in Italy, 24% in Greece, and rising.

At Iceland's central bank— mercifully, no longer listed beside al Qaeda as a terrorist body by UK authorities— Governor Svein Harald Oygard says currency therapy is working as it should. "If you lean back and look you can see that fall of the krona accentuated the shock at first, but it is also now working as a turbocharger for recovery. We've seen a strong hit on wealth and asset values, but the story for real economy is very different."

Devaluation is always double-edged. Some 13% of households in Iceland hold mortgages in euros, Swiss francs, or God forbid, yen. Their debt levels doubled overnight. Some 70% of corporate loans are in foreign currencies. Exporters are hedged. Those that earn in krona are not, and a "large number" are now in dire straits.

The Governor is a Norwegian who cut his teeth in the Oslo banking crisis of the early 1990s. He was brought in as a troubleshooter after the last crew was literally banged out of the Sedlabanki by the 'Saucepan Revolution' in February. With justifiable pride, he showed me the latest trade figures. Iceland has defied the global shipping crash to eke out an 11% rise in exports over the last year. Even China has seen a fall of 21%. [[Wonder if he would consider replacing BB at the Fed!?!: normxxx]]

Iceland will be back in surplus by next year, from a peak deficit of 25% of GDP. You could say the same about Latvia, which has stuck to its euro peg under orders from Brussels. But there is a big difference. Latvia is balancing its books by crushing demand. Exports are down 28%, but imports are down even more. The result of this Stone Age policy is economic contraction of 18% this year, and 4% in 2010 (state data).

Icelanders have taken a hit, of course. Unions have accepted 'real' wage cuts of 10%. [[Which I believe at current rates of inflation, still amounts to a decent 'nominal' raise.: normxxx]] Health care and welfare are being cut 5%, education 7%, and the rest 10%. This is comparable to what is happening in Ireland, but again there is a difference. Dublin faces a Sysphean task as collapsing tax revenues force ever deeper austerity: Reykjavik is over the worst.

It baffles me why rating agencies still talk of downgrading Iceland's debt to junk. The country should emerge with public debt of 80% to 100% of GDP— much like Britain. Yet Iceland also has the world's best-funded pension system at 120% of GDP. It is the two together that counts. In their angst, Icelanders look wistfully at the apparent safe port of EU membership. The Althingi has voted to start entry talks. But the storm will have blown over well before an EU referendum is held in two or three years. By then the delayed cluster bomb of Europe's unemployment will have detonated. Try selling EU protection then.

Foreclosures Are Often In Lenders' Best Interest

Foreclosures Are Often In Lenders' Best Interest
Numbers Work Against Government Efforts To Help Homeowners

By Renae Merle, WP | 29 July 2009

Government initiatives to stem the country's mounting foreclosures are hampered because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes than to work out settlements, some economists have concluded. Policymakers often say it's a good deal for lenders to cut borrowers a break on mortgage payments to keep them in their homes. But, according to researchers and industry experts, foreclosing can often be more profitable.

The problem is that modifying mortgages is profitable to banks for only one set of distressed borrowers, while lenders are actually dealing with three very different types. Modification makes economic sense for a bank or other lender only if the borrower can't sustain payments without it yet will be able to keep up with new, more modest terms.

A second set are those who are likely to fall behind on their payments again even after receiving a modified loan and are likely to lose their homes one way or another. Lenders don't want to help these borrowers because waiting to foreclose can be costly. Finally, there are those delinquent borrowers who can somehow, at great sacrifice, catch up without a modification. Lenders have little financial incentive to help them.

Special Report: Foreclosure Prevention Program— Homeowners' Calculus

'Triage' Tool: The Lenders Calculus

These financial calculations on the part of lenders pose a difficult challenge for President Obama's ambitious efforts to address the mortgage crisis, which remains at the heart of the country's economic troubles and continues to upend millions of lives. Senior officials at the Treasury Department and the Department of Housing and Urban Development have summoned industry executives to a meeting Tuesday to discuss how to step up the pace of loan relief. The administration is seeking to influence lenders' calculus in part by offering them billions of dollars in incentives to modify home loans.

Still, foreclosed homes continue to flood the market, forcing down home prices. That contributed to the unexpectedly large jump in new-home sales in June, reported yesterday by the Commerce Department.

"There has been this policy push to use modifications as the tool of choice," said Michael Fratantoni, vice president of single-family-home research at the Mortgage Bankers Association. But "there is going to be this narrow slice of borrowers for which modifications is the right answer". The size of that slice is tough to discern, he said. "The industry and policymakers have been grappling with that."

The effort to understand the dynamics of the mortgage business comes as the administration is prodding lenders to do more to help borrowers under its Making Home Affordable plan, which gives lenders subsidies to lower the payments for distressed borrowers. About 200,000 homeowners have received modified loans since the program launched in March, while more than 1.5 million borrowers were subject during the first half of the year to some form of foreclosure filings, from default notices to completed foreclosure sales, according to RealtyTrac. No doubt part of the explanation is that lenders are overwhelmed by the volume of borrowers seeking to modify their mortgages. Rising unemployment and falling home prices have added to the problem.

But a study released last month by the Federal Reserve Bank of Boston was downbeat on the prospects for widespread modifications. The analysis, which looked at the performance of loans in 2007 and 2008, found that lenders lowered the monthly payments of only 3 percent of delinquent borrowers, those who had missed at least two payments. Lenders tried to avoid modifying the loans of borrowers who could "self-cure," or catch up on their payments without help, and those who would fall behind again even after receiving help, the study found.

"If the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily 'preventable' foreclosures may be far smaller than many commentators believe," the report said. Nearly a third of the borrowers who miss two payments are able to self-cure without help from their lender, according to the Boston Fed study. Separately, Moody's Economy.com, a research firm, estimated that about a fifth of those who miss three payments will self-cure.

When Adrian Jones fell behind on the mortgage payments for her Dallas home earlier this year, her lender asked her to cut other expenses. Jones said she eliminated movies and coffee breaks. She turned to family members for loans. When that failed to raise enough, she sold her second car. "It hurt, but it also made sense. The debt was my responsibility," Jones said.

But six months later, after catching up on the mortgage, Jones is again feeling pinched after her hours as an office assistant at an architecture firm were cut. This time, she's not sure she can fix the problem herself. "I am going to try, obviously," she said. "But it is getting harder and harder". Like Jones, those who are most determined to meet their obligations are often unlikely candidates for loan modifications.

"These are the people who will get a second job, borrow from their family to keep up," explained Paul S. Willen, a senior economist at the Federal Reserve Bank of Boston and an author of its report. "… From a cold-blooded profit-maximizing standpoint, these are the people the banks will help the least". Lenders also worry that borrowers may re-default even after receiving a loan modification.

This only delays foreclosure, which can be costly to the lender because housing prices are falling throughout the country and the home's condition may deteriorate if the owner isn't maintaining it. In some cases, lenders lose twice as much foreclosing on a home as they did two years ago, said Laurie Goodman, senior managing director at Amherst Securities. American Home Mortgage Services, based in Texas, was willing to modify Edward Partain's mortgage on his Tennessee home last April after business at his beauty salon slowed and a divorce stretched his budget.

But after months of negotiating with his lender, Partain said he was surprised to learn that it would only lower his payments by $90 a month, instead of the $250 decrease he expected. "At $250, I would have had a chance, but after they added in late fees and payments, I couldn't do it," he said. Partain soon fell behind on his payments again and went back to American Home Mortgage Services seeking a more affordable payment. Partain said he was told that he was ineligible for another modification because it had been less than a year since his last. A foreclosure sale was scheduled for late July.

After American Home Mortgage Services was contacted by The Washington Post about the case, the company said Partain would be considered for the federal foreclosure-prevention program and it delayed the sale by three months. Partain is relieved but anxious about the details. "You want to wait and see what figures they come up with," he said.

Administration officials have not said publicly how many borrowers they expect to re-default under Obama's program. But the experience of a separate program run by the Federal Deposit Insurance Corp. could be instructive. After taking over the failed bank IndyMac last year, the FDIC began modifying troubled mortgages held or serviced by the company. Richard Brown, the FDIC's chief economist, said the agency expects up to 40 percent of those borrowers to re-default.

Even at that rate, he said, the modification program is more profitable than doing nothing. "The idea that a 30 to 40 percent re-default rate represents a program failure, is false," Brown said. The administration has estimated that its foreclosure-prevention program would help 3 million to 4 million borrowers by 2012. But lenders' reluctance could limit the impact to less than half that, said Mark Zandi, chief economist for Moody's Economy.com. Coupled with re-defaults, this would mean that the number of people losing their homes to foreclosure could reach nearly 5 million by 2011, he said.

Mark A. Calabria, director of financial-regulation studies at the Cato Institute, warned that political rhetoric is driving the policy discussion. "What we really need to do is have an honest debate about what are the magnitudes of people we really can help," he said. But administration officials defended their program's progress, reporting that it has surpassed an initial goal of offering 20,000 modifications a week. These officials said they have taken into account the re-default risk and possibility for self-cure in designing the effort.

Michael S. Barr, assistant Treasury secretary for financial institutions, noted that the report by the Boston Fed does not cover the period since the administration launched its initiative. "We will continue to refine the program as new data becomes available," he said. "We are committed to studying the effectiveness and efficiency of the program, and we welcome outside analysis."

Willen, of the Boston Fed, said the government program could boost several-fold the number of seriously delinquent borrowers receiving modifications. But so few people had been getting their loans modified that even a dramatic increase in the percentage would still touch only a small fraction of troubled borrowers, he said. "We're still not talking about a program that will stop a large number of foreclosures," he said. "We're talking about a program that, at the margins, will assist more people. It is unlikely we will see a sea change."

It's Already Worse Than The Depression

It's Already Worse Than The Depression

By Robert Brokamp, Motley Fool Stock Advisor | 23 June 2009

Remember all that talk about whether we were entering another Great Depression? Much of it has subsided since the 30% rally in the S&P 500 and the sprouting of the economy's supposed "green shoots" (or, as skeptics call them, "yellow weeds," "Venus flytraps," or "poison ivy accidentally used as toilet paper"). But you'll still find doomsayers who think the worst is yet to come. (And I mean "doomsayers" in a good way— there should be a little part of all of us that expects the worst and plans accordingly.)

Whether or not our current 'less-bad' economy— when most economic metrics are still ugly, just not as ugly as they used to be— sort of like me in college— is really an indication of "green shoots" or more like the worm-like tongue of the alligator snapping turtle remains to be seen. But I can tell you this: By at least one metric, it's already worse than the Depression at this point in relative time: the Dow then was down only 12% at the apex of the post-1929 crash rally; we're now still down 32%.

It Didn't Have To Be That Bad

But wait. Some investors did see their portfolios grow over the past decade. How did they do it? By owning asset classes other than U.S. large-cap stocks. While those returns won't turn a pauper into Prince (or whatever his name is these days), they're still better than losing money. And investors who had these more-diversified portfolios ended up with almost twice as much money as someone in an S&P 500 index fund.

In my Rule Your Retirement service, I have created model portfolios that contain 10 to 12 asset classes. Let's take a look at how a few fared over the past 10 years using mutual funds (mostly of the index variety) to measure their performance, compared with an investment in the Vanguard 500 (FUND: VFINX), our proxy for U.S. large-cap stocks.

Portfolio	Investment(s)	Total 10-Year Return	$100,000 Turned Into …
100% U.S. large-cap stocks	One fund	(22.8%)	$77,160
100% stocks, of all sizes and countries	10 funds	31.4%	$131,414
70% stocks, 30% bonds	11 funds	47.3%	$147,325

Source: Morningstar Principia software, May 1, 1999, to April 30, 2009. Portfolios are rebalanced annually.

What makes these portfolios different? They're built with funds that invest all over the world, in stocks of all types and sizes. They still have the big-name American companies— such as Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM)— but also small stocks, such as Seagate Technology (Nasdaq: STX) and ImmunoGen (Nasdaq: IMGN). And they're not limited to America, either, including funds that invest in stocks like Nokia (NYSE: NOK) and China Mobile (NYSE: CHL).

And then there's boring old bonds, which made up 30% of the third portfolio. You should own them— especially if you're within a decade of retirement, or just can't stand the volatility (or, perhaps most important) uncertainty of an all-stock portfolio. [[Not to mention that bonds have outperformed stocks over the past 5, 10, 15, 20 and 25 years!: normxxx]] Of the portfolios above, the one with bonds did best.

Hope For The Future

Just as in the 2000s, holding bonds beat an all-stock portfolio in the 1930s. However, it wasn't until the 1970s that bonds once again reduced risk and boosted return over decade-long time frames. In each case, one bad decade for stocks was followed by a multidecade run of good returns. Put another way, since 1926, U.S. large-cap stocks have never posted two consecutive decades of losses. That gives us some hope for the coming decade.

Of course, there's a first time for everything. In 2005, Ben Bernanke, then an advisor to President Bush, said on CNBC, "We've never had a decline in housing prices on a nationwide basis. What I think is more likely is that house prices will slow, maybe stabilize … I don't think it's going to drive the economy too far from its full-employment path, though". Well, we've since had our nationwide decline in housing prices. (That gnawing sound you hear is Mr. Bernanke eating his words.) Given that history is a useful yet imperfect guide, it's likely— though not guaranteed— that stocks will post decent[!?!] returns over the next decade.

So for those near or in retirement, or for conservative investors of any age, using bonds to balance the risk of stocks makes sense. And every investor should hold stocks of all shapes, styles, sizes, and nationality. It would be grand to know which type of investment will do best over the next decade. But until you've fixed your crystal ball or perfected time travel, a smartly created, well-diversified portfolio should be the foundation of your retirement savings.

See also Paul Merriman's "The Ultimate Buy-and-Hold Strategy" for actual alternative portfolios.

Fiscal Ruin Of The Western World Beckons

Welcome To The Eye Of The Storm
Second Half, 2003… or 1987!?!
Fiscal Ruin Of The Western World Beckons
9 Reasons Jobs Won't Recover Soon;
7 Reasons Why Housing Isn’t Bottoming Yet

By John Galt | 23 July 2009

The Dow has rallied nicely since March of this year.

[ Normxxx Here:  Even as the dollar has cratered (be careful; note the different starting points)… Click Here, or on the image, to see a larger, undistorted image. Expect this relationship to hold… and who knows where the dollar will end… Colin Twiggs: "…The euro broke out above the recent triangle against the greenback, signaling a primary advance with a target of $1.50. Follow-through above $1.43 would confirm the signal. Reversal below $1.38 is unlikely, but would warn of reversal to a primary down-trend". Bill Cara: "I am on the record as saying I think the $USD will hold at this level for the short-term although— and this is quite connected— $GOLD would make a run to close to $1,000. Here’s what I now think. President Obama’s healthcare legislation efforts lie in the balance; therefore, the Fed must keep rates down a while longer, but also continue to support the Dollar. The odds of a replay of Black Monday October 19, 1987 are rising… "So, bottom line (Cara): there will be some false break-downs in the US Dollar in the near-term, causing $GOLD to lift— one final time in this short- and intermediate-term cycle. The stock promoters will be active this summer. Their well-paid newsletter writers will come through with wonderful stories. The people will buy. $GOLD maybe hits $1,000, possibly a bit higher before the cycle ends abruptly." normxxx: The S&P will top 1000 this summer together with gold… But, then comes the fall…  ]

Washington, D.C. appears to be returning to the 'good' status of "stalemate" which satifies the world. The "War against Terror" is now 'the police action against misguided radicals'. All must be well with the world because U.S. bankster profits are [once again] off the scale [[thanks to some very funny accounting: normxxx]] and I swear 'Maria the Money Honey' had an actual Bubblegasm reporting Apple’s earnings this afternoon.

Welcome to the eye of the storm. And that storm, as displayed above, is Hurricane Wilma, the most intense storm in recorded history. That storm is getting ready to move again and the most powerful part of the eyewall is about to slam into our economic fantasy land at full force.

Without going into great detail, let me try to outline in brief the series of events which will be swirling like the eye wall, with 200 mph gusts and record low pressure. Duck if you see one of those buildings coming at you, it’s probably a foreclosed home being 'wiped off' the books.

1. Iran— Israel will not sit by idly waiting on the Messiah to ‘talk’ to them, they will act. Fall would be the perfect time as the Iranian defenses should be exhausted from all the probing. [[Not to mention riots in the street.: normxxx]]

2. The banking system is still extremely unstable. Despite saving those deemed "too large to fail"— now there are too many [little ones] to 'save'. The rumors about a bank holiday are swirling— but what would be logical (good luck with this one) is if they did execute such an action, consolidate or close the 2000 or so bad banks, put the assets into a RTC style liquidation firm, then re-open in less than 14 days, it might work. But the panic it would create would be astonishing at every level. [[Forget it; it would take a veritable army of CPAs, attorneys, etc.— none of whom are in sufficient quantity for even the current operations of the Fed.: normxxx]]

3. The U.S. Dollar is losing steam and the threats made by the BRIC nations to create separate trading blocs that do not use the USD is becoming reality. Without its reserve currency status— which will not be at risk this year, but just the threat of that action— the U.S. dollar is little more than an Argentine peso, albeit from a country with a big navy, air force and ['repurposeable'] ICBMs.

4. Unemployment is deteriorating at a faster and deeper level than any projections. According to numbers produced from various sources, unemployment really ranges from 18.2% to over 20.6% which matches some of the estimated 1893 and 1930’s depression levels.

5. Derivatives: From Martin Weiss July 10th— The Giant Accumulation of High-Risk Debts and Bets Called "Derivatives"

A must read and I really do not have much more to add to this subject as the risk is now on full display with the still ongoing three 'circus rings' of the monoline insurers, AIG, and CIT.

6. Swine Flu— As of this entry there just may be a vaccine, but the virus is rapidly mutating making it difficult to create an effective vaccine. This challenge could create another flu panic this autumn and winter that further impacrts our financial system. [[But I'm looking out for the 'double dip' as more likely in Fall, 2010.: normxxx]]

7. Bankruptcies— Personal and Corporate bankruptcies are accelerating and as we head into the fiscal year end for many corporations, Chapter 11 could be a viable option. As individuals lose hope and can not escape the debt spiral they are filing at a pace unseen since the modification to the bankruptcy laws in 2005.

8. The P/E ratio for the S&P 500 is an absurd 15.74 on forward earnings and the NASDAQ an even more absurd 19.22. Traditional recession level ratios are between 5 and 8 (Source WSJ, 7/21). Considering the spin being put on earnings this week, the potential for a major corrective move to the downside is wide open. [[But much more likely to strike in the 3Q, since 2Q earnings estimates were (often absurdly) low-balled, but 3Q earnings estimates are now hastily being revised upwards: normxxx]]

9. Manufacturing is not recovering— just slowing its descent— with little evidence that the automotive sector will 'spring' quickly back to life. New single family home construction trailing levels have been unseen since before 1958, and there is no logical reason to think the 'housing recovery' has begun (see item 12).

10. The retail disaster is still ongoing with further bankruptcies likely, including some historic and major names which will add further pressure to an already devastated Commercial Real Estate market.

11. Import/Export data via rail car bookings, TEU container counts, etc. indicates that our export markets are still declining at about 14-29% per month depending on the port and our imports are still declining at a 20-28% decline year over year. Thus validating a continuing manufacturing disaster.

12. Real Estate Reality— Despite a mass move of foreclosed homes, the banksters are still sitting on numerous months of inventory which have not been put up for bid or worse, have often postponed final foreclosure action to prevent further market price deterioration [[an estimated 8-10 months delay between first non-payment and final auction, if any— and, despite all, new foreclosures are accelerating faster then the banks can get rid of the old ones. See also "What Can a Half Century of Housing Inventory Data and Past Recessions Tell Us?"; "Lenders Abandoning Foreclosed Properties"; and "In 'Foreclosure Limbo'".: normxxx]].

Add in the CRE disaster which is starting to pile up and the projected delinquency rates in the 8K’s for the real commercial banks (not Goldman) and you can see that any improvement is [very likely] seasonal only and will resume a steep deterioration in the fall.

That's why I am keeping up the 'hurricane warning' signs for everyone. For those of you who have never experienced a storm like this, the eye is the deceiving part. You can either keep the storm shutters on and get ready for the worst part of the storm or you can be like the idiots on Bubblevision [[and at the Fed?: normxxx]] and begin taking the storm protection down. For what it is worth, I think Dennis Kneale (CNBC) is that fool you see in every storm with a beer can in one hand trying to lean into the 150 mph winds right before a tin awning cuts him in half. In other words, as every other economic storm in our history, there is always some fool proclaiming "this is nothing, come on out, enjoy the rain"; famous last words, like these, don’t you think? :

"…there are indications that the severest phase of the recession is over…"
— Harvard Economic Society (HES) Jan 18, 1930

.

Fiscal Ruin Of The Western World Beckons

By Ambrose Evans-Pritchard | 22 July 2009

For a glimpse of what awaits Britain, Europe, and America as budget deficits spiral to war-time levels, look at what is happening to the Irish welfare state. Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15% of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous compounding debt trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12% and heading for 16% next year. Education must be cut 8%. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland. Nobody is spared. Social welfare payments must be cut 5%, child benefit by 20%. The Garda (police), already smarting from a 7% pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

"Something has to give," said Professor Colm McCarthy, the report's author. "We're borrowing €400m (£345m) a week at a penalty interest."

No doubt Ireland has been the victim of a savagely tight monetary policy— given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.

As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a "penalty interest" on British Gilts, given the trajectory of UK national debt— now vaulting towards 100% of GDP— and the scandalous refusal of this Government to map out any path back to solvency.

"The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever," said the Fund.

France and Italy have been less abject, but they began with higher borrowing needs. Italy's debt is expected to reach the danger level of 120% next year, according to leaked Treasury documents. France's debt will near 90% next year if President Nicolas Sarkozy goes ahead with his "Grand Emprunt", a fiscal blitz masquerading as investment.

There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's 'Lost Decade' (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans— famously building 'bridges to nowhere' in Hokkaido— has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240% of GDP by 2014— beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up.

Error One was to permit the bubble in the 1980s. Error Two was to wait a full decade before opting for monetary "shock and awe" through quantitative easing. The US Federal Reserve has moved far faster, but already seems to think the job is done. "Quantitative tightening" has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of "exit strategies".

Is this a replay of mid-2008 [[or 1936: normxxx]] when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2% in 2008)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.

The Fed's doctrine— "New Keynesian Synthesis"— has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer. The imperative for debt-bloated Western [governments] is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.

My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.

.

9 Reasons Jobs Won't Recover Soon

By Mortimer Zuckerman, U.S. News & World Report | 20 July 2009

Job losses over the past 6 months have exceeded anything we've experienced since World War II, and the number (and percentage) of long-term unemployed is at an all-time high. There are signs the recession may end in coming months, but recovery is likely to be so listless that many won't feel the difference, says The Wall Street Journal's David Wessel.

Recent unemployment numbers have undermined confidence that we might be nearing the bottom of the recession. The appropriate metaphor is not the green shoots of new growth. It's better to view the total of jobless people as a prudent navigator perceives an iceberg. What we see on the surface is disconcerting enough. The Bureau of Labor Statistics estimate of 467,000 jobs lost in June increases to 7.2 million the number of unemployed since the start of the recession.

The cumulative job losses over the past six months have been greater than for any other half-year period since World War II, including demobilization. What's more, the job losses are now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all employment growth from the previous business cycle. That's bad enough. But here are nine reasons we are in even more trouble than the 9.5% unemployment rate indicates:

1. June's total included 185,000 people assumed to be at work but many of whom probably were not. The government could not identify them; it made an assumption about trends. But many of these mythical 'estimated' jobs were 'imputed' in industries such as finance that, in fact, have absolutely no job creation. As official numbers are adjusted over the next several months, some of those 185,000 will likely be added back to the unemployment totals.

2. More companies are asking employees to take 'unpaid leave'. These people don't count on the unemployment rolls.

3. At least 1.4 million people weren't counted among the unemployed, even though they wanted work or were available in the past 12 months. Why? Because they hadn't searched for work in the four weeks preceding the survey. The assumption is that they had found work or don't want it, but there are other explanations: school attendance, family responsibilities, sheer exhaustion.

4. The number of workers taking part-time jobs because of the slack economy, a kind of stealth underemployment, has doubled in this recession to about 9 million, or 5.8% of the work force. Add those whose hours have been cut and the total of unemployed and underemployed rises to 16.5%, putting the number of involuntarily idled workers in the range of an overwhelming 25 million.

5. The inside numbers are just as bad. The average workweek for production and nonsupervisory private-sector employees, around 80% of the work force, dropped to 33 hours. That's 48 minutes a week less than before the recession began, the lowest level of (weekly) activity since the government began tracking such data 45 years ago.

Full-time workers are being downgraded to part-time as businesses slash labor costs to remain above water. Factories are operating at only 65% of capacity. If American workers were still putting in those extra 48 minutes a week, 3.3 million fewer employees could perform the same aggregate amount of work. With the longer workweek, the unemployment rate would reach 11.7%, not the official 9.5% (which in turn dramatically exceeds the 8% rate projected by the Obama administration).

6. The average length of official unemployment increased to 24.5 weeks. This is the longest term since the government started to track these data in 1948. The number of long-term unemployed (those out of a job for 27 weeks or more) has now jumped to 4.4 million, an all-time high.

7. The average worker saw no wage gains in June, with average compensation running flat at an average of $18.53 an hour.

8. The jobs report is even uglier when you consider that the sector producing goods is losing the most jobs— 223,000 in the last report alone.

9. The prospects for job creation are equally distressing. The likelihood is that when economic activity picks up, employers will first choose to increase hours for existing workers and bring part-time workers to full-time status.

Many unemployed workers looking for jobs once the recovery begins will discover that jobs as good as the ones they lost are almost impossible to find because more layoffs in this recession have been permanent and not temporary. Instead of shrinking operations, companies have closed whole business units or made sweeping structural changes in the way they conduct their business. For example, General Motors and Chrysler shut down hundreds of dealerships and reduced brands; Citigroup (C) and Bank of America (BAC) cut tens of thousands of jobs and exited many parts of the world of finance.

In other words, we could face a very low upswing in terms of the creation of new jobs, and we may be facing a much higher level of joblessness on an ongoing basis. Job losses may last well into 2010, and unemployment may peak at close to 11%. Can we find comfort in knowing that employment has long been considered a lagging indicator? It is conventionally seen as having limited predictive power because employment reflects decisions taken earlier in the business cycle.

But today is different.

Unemployment doubled from 4.8% to 9.5% in just 16 months, a rate so rapid it may influence future economic behaviors and outlooks. Bear in mind that the lackluster increase in inventories suggests that there's little prospect of real growth in consumption, investment or exports. So the terrible state of the labor market is likely to be a strong headwind against consumer spending as wages and overall income growth are decelerating.

And households soon will have received their full portion of the stimulus package. How could this happen when Washington has thrown trillions of dollars into the pot, including the famous $787 billion in spending that was supposed to yield $1.50 in growth for every dollar spent? For a start, too much of the money went to transfer payments— Medicaid, jobless benefits and the like— that do nothing for jobs and growth. The spending that creates jobs is new spending, particularly on infrastructure. [[But, as Japan has aptly demonstrated over almost 20 years, such spending— necessary as it is— seems to be almost useless as a "kickstart" for the economy.: normxxx]] It amounts to less than 10% of the stimulus package today.

Second, while the stimulus package may have been well intentioned, it was too small and too badly constructed to get money into the economy fast enough to replace lost consumer and business spending and to slow unemployment. Workers' pessimism is justified: About 40% believe the recession will continue for another full year. And, as paychecks shrink or disappear, consumers are more hesitant to spend and won't lead the economy out of the doldrums quickly enough.

It may have made him unpopular in parts of the Obama administration, but Vice President Joe Biden told it as it is when he said the administration misread how bad the economy was. The administration inherited the problem but then failed to understand how ineffective its solutions would be. The program was supposed to be about jobs, jobs and jobs. It wasn't. The recovery act included thousands of funding schemes for tens of thousands of projects, but those programs are stuck in the bureaucracy as the government releases funds with typical inefficiency.

An additional $150 billion, allocated to state coffers to continue existing programs like Medicaid, did not add jobs. Hundreds of billions of dollars were set aside for tax cuts and for benefits for the poor and the unemployed, and that did not add jobs. Now, state budgets are drowning in red ink as jobless claims and Medicaid bills climb.

Next year, states will have depleted their initial rescue dollars. Absent another rescue plan, they will have no choice but to slash spending or raise taxes, or both. The state and local government sector, comprising about 15% of the economy, is beginning the worst contraction in post-World War II history in the face of a deficit gap of $166 billion for fiscal 2010, according to the Center on Budget and Policy Priorities, and a cumulative gap of $350 billion in fiscal 2011.

Similarly, households overburdened with historic levels of debt will be [[mostly involuntarily: normxxx]] saving more. The savings rate has already jumped from zero in 2007 to almost 7% of after-tax income and is rising. Every dollar of saving comes out of consumption. Because consumer spending is the economy's main driver, we are going to have a weak consumer sector, and many businesses simply won't have the means or the need to hire employees.

In the aftermath of the 1990-1991 recession, Americans bought houses, cars and other expensive goods. This time, the combination of a weak job picture and the (continuing) severe credit crunch means that people won't be able to get the financing for big expenditures, and those who can borrow will be reluctant to do so. In recent times, Americans found myriad ways to fuel spending, even as incomes stagnated, by borrowing against once-rising home values, by tapping credit cards… No longer. The paycheck has returned as the primary source of spending, and pay is eroding even for those who have jobs. [[Welcome to deflation, stage I: normxxx]]

This process is nowhere near complete, and, until it is, the economy will barely grow, if at all, and may well oscillate between sluggish growth and modest decline for the next several years until the rebalancing of over 30 years of an accumulated excessive debt has been completed. Until then, the private economy will be starved of adequate credit, profits and cash flow, and businesses will not hire for expansion. Nor will they race to make capital expenditures when they have vast idle capacity.

In other words, there are many more reasons today to expect the downturn to continue than to expect a turnaround. Consumer spending and residential investment could be even weaker than most estimates, and, as the level of fiscal stimulus starts to decline in the second half of 2010, we may be facing an even more difficult future. No wonder poll after poll shows a steady erosion of confidence in the stimulus measures. One survey showed 45% believe the limited results suggest they should simply be abandoned midway. The disappointment is understandable, but that would only make things worse.

So what kind of second-act stimulus program should we look for? This time, it should not be an excuse to pass a lot of programs that don't really have a multiplier effect on job creation and economic growth. And it should not be a handout for the fat-cats. Given the trends, it is critical that the Obama administration not play politics but begin to prepare a second stimulus program to sidestep a major downturn. It will be possible this time to provide much more rapid government support to infrastructure spending that will maximize the creation of jobs.

The time to get ready is now.

.

7 Reasons Why Housing Isn’t Bottoming Yet
Click here for a link to complete ORIGINAL article:

By Barry Ritholtz | 20 July 2009

On Saturday, I posted the chart above and wondered why "Some people were calling for a housing bottom". That generated a ton of emails asking about further clarification. The people I referred to [in the quote] were mostly the usual happy talk TV suspects (i.e., Cramer) who have been perpetually wrong about Housing for nigh on 3 years. I not only disagree with them, but don’t respect their opinion— essentially headline reading, gut instinct, big-money-losers. No thanks.

Then there were the slew of MSM who insist each month on reporting that 3% (±11%) is a positive integer. We disposed of that silliness on Friday.

But the crux of the email was over this post. There are a handful of people whom I disagree with, but nonetheless have a great deal of respect for [because of] their [sound] methodology and process. Over the past year, these have included Doug Kass and Lakshman Achuthan and Bill of Calculated Risk. We may reach different conclusions about a given issue, or disagree on timing, but these are the folks whose opinions force me to sharpen my own.

When I tossed up that chart yesterday, I had not yet seen Bill’s comments on the subject (McCartney!) but he is one of those people I can respectfully disagree with. We simply have reached different conclusions about the timing and shape of the eventual Housing lows. There are a plethora of reasons why I believe we are nowhere near a bottom in Housing prices or activity.

Here are a few:

• Prices: By just about every measure, Home prices on a national basis remain elevated. They are now far off their highs, but are still remain about ~15% above their historic metrics. I expect prices will continue lower for the next 2-4 quarters, if not longer, and won’t see widespread Real increases for many years after that; Indeed, I don’t expect to see nominal increases anytime soon;

• Mean Reversion: As prices revert back towards historical means, there is the very high probability that they will careen past the median. This is the pattern we see after extended periods of mispricing. Nearly all overpriced asset classes revert not merely to their historic trend line, but typically collapse far below them. I have no reason to believe Housing will be any different;

• Employment & Wages: The rate of Unemployment is very likely to continue to rise for the next 4-8 quarters, if not longer. This removes an increasing number of people from the total pool of potential home buyers. There is another issue— Wages have been flat for the past decade (negative in Real terms), crimping the potential for families to trade up to larger houses— a big source of Real Estate activity. Plus, more unemployment means more . . .

• Foreclosures: We likely have not seen the peak in defaults, delinquencies and foreclosures. Many more foreclosures— which are healthy in the long run but wrenching during the process of dislocation— are very likely. These will pressure prices yet lower. And Loan Mods are not working— they are being redefaulted on in less than a year at between 50-80%, depending upon the mod conditions themselves.

• Inventory: There is a substantial supply of "Shadow Inventory" out there which will postpone a recovery in Home prices for a significant period of time. These are the flippers, speculators, builders and financers that are sitting with properties that they do not want to bring back to market yet. Given the extent of the speculative activity during the boom years (2002-06), and the number of foreclosures so far, my back of the envelope estimates are there are anywhere from 1.5 million to as many as 3 million additional homes that could come to market if prices were more advantageous.

• Psychology: The investing and home owning public are shell shocked following the twin market crashes and the Housing collapse. First the dot com collapse (2000-03) saw the Nasdaq drop about 80%, then the Credit Crisis of 2008 saw the unprecedented near halving of the market in about a year. Last, Homes nationally have lost about a third of their value since the 2005-06 peak. Total losses to the family balance sheet of these three events are about $25 trillion dollars. These losses not only crimp the ability to make bigger purchases, it dramatically curtails the willingness to take on more debt and leverage. Speaking of which . ..

• Debt Service/Down Payment: Far too many Americans do not have 20% to put down on a home, have poor credit scores, and way too much debt. All of these things act as an impediment to buying a home. At the same time, to get approved for a mortgage, banks are tightening standards, including 1) requiring higher Loan to Values for purchases; 2) better credit scores to get approved for a mortgages; 3) Lower levels of overall debt servicing relative to income for applicants. Yes, the NAR Home Affordability Index shows houses as "more affordable," but it conveniently ignores these [other] real world factors.

• Deleveraging: For the first time in decades, the American consumer is in the process of saving money and deleveraging their balance sheets. After a 40 year credit binge, it's long overdue. The process is likely to go on for years, as a new generation is losing confidence in the stock market, Corporate America and their government. Think back to the post-Depression generation that were big savers, modest consumers, who eschewed credit and borrowing. The damage is going to take a while to repair.

• Zero % Interest Rates: As many have written, when rates are this low, they only have one direction to go: Up.

There are more reasons I expect the Real Estate market to remain punk for many years, but these are a good place to start when considering the question. The Housing Boom & Bust, and the 2002-07 credit bubble created massive excesses. More than anything, it is going to take time to resolve them. [[Probably at least as long as it took to create them in the first place! : normxxx]]

More Doom and Gloom

Modeling the Market: Dow Jones Industrial Average (DJIA) Model Click here for a link to ORIGINAL article: "In fact, there are several other possible outcomes from here [than a 'repeat' of the last 40 years, which would give us Dow 40,000 by 2020]. One is the market will move in a range like it did during the 1960s and 1970s. Another scenario has the DJIA following the Japanese experience and going into a very long decline. "In the late 1980s, Japan had explosive growth in sharemarket prices, similar to the DJIA in the late 1990s. The euphoria in Japan was driven by healthy export growth, but especially by a housing and construction boom. The real estate bubble burst in the early 1990s and the Japan market started to plunge. Japan has been in and out of recession ever since, and the latest stock meltdown from late 2007 has seen the value of the Nikkei 225 (an index of the top 225 companies in Japan, something like the DJIA in the USA) return to values last seen in early 2003, and before that, in 1983. "Investors who were in the market during the 1980s did very well, but since then, many people have lost a lot of money. The graph of the Nikkei 225 since 1975 is as follows: Click Here, or on the image, to see a larger, undistorted image. "The early part of this chart is quite similar to the exponential rise of the DJIA and it is interesting that both stock bubbles were in part fuelled by real estate bubbles. If the DJIA unwinds over the next 20 years in a similar fashion to the Nikkei, we might see a return to values last seen in the 1980s. "In this next graph, I have superimposed the DJIA (in dark red) and the Nikkei (in dark blue). The period from 2003 to 2007 for the DJIA has a remarkably similar shape to the runup for the Nikkei from Dec 86 to Dec 1989. The wipeout that followed is also very similar. The Dow's low of near 7500 in Oct 08 corresponds to the Nikkei's low of around 20000 in late 1990. Click Here, or on the image, to see a larger, undistorted image. "So will the Dow follow the Nikkei's pattern over the next 20 years? We hope not, but if so, we can expect the DJIA to be somewhere around 2000 to 3000 at that time (2029), or less than one third of its current value (as at July 2009). That will make a lot of retirees seriously unhappy."

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

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]]

'Lazy Portfolios' Seven-Year Winning Streak

Lazy Portfolios Seven-Year Winning Streak
Strategy Keeps Beating S&P 500 As Well As Popular Actively Managed Funds

By Paul B. Farrell | 9 July 2009

ARROYO GRANDE, Calif. (MarketWatch)— Guess what? Actively managed mutual funds are bad news, filching your hard-earned money. Year after year they continue their dark legacy, proving what former Sen. Peter Fitzgerald said during his reform fight five years ago: "The mutual fund industry is now the world's largest skimming operation, a $7 trillion trough from which fund managers, brokers and other insiders are steadily siphoning off an excessive slice of the nation's household, college and retirement savings".

The fund industry defeated the senator's efforts. Back then Morningstar's boss Don Phillips added that funds had "lost their moral compass". Today it's far worse. Greed drives this industry. The "world's largest skimming operation" has now lost over 50% of America's savings in the decade since the peak of 2000. The track record of actively managed funds during the recent subprime-credit meltdown continues to prove that the industry is failing America.

The only way to invest is with index funds, which make up just 14% of the total. As "Kiplinger's Annual Guide" once said about building index-fund portfolios: "If you're picking from among the best funds to start with, then all you really need for diversification is three stock funds and one bond fund— and you can forget the other 9,111 funds". Yes, forget about 99.9% of all mutual funds.

As Vanguard's founder Jack Bogle succinctly put it:

"Common sense tells us— and history confirms— that the simplest and most efficient investment strategy is to buy and hold all of the nation's publicly held businesses at very low cost. The classic index fund that owns this market portfolio is the only investment that guarantees you with your fair share of stock market returns."

A portfolio of index funds does the trick because it's diversified broadly across more than a thousand stocks and bonds in the market.

Let's Rumble: Lazy Investors Vs. Active-Managed Competition

Still skeptical? OK, the facts, and a competition. Let's compare the performance of a half dozen of America's most popular actively managed funds touted in ads and the financial press over the years. We'll compare them to our eight Lazy Portfolios. As you do, keep in mind one crucial point: The big sales pitch for actively managed funds is that their managers are supposed to "add value" by beating the market indexes, right? Wrong.

For comparison, we picked six perennially popular funds: Fidelity Magellan, Dodge & Cox Stock, Legg Mason Value, Janus Fund, Baron Growth and American Funds' Washington Mutual. And keep in mind the compensation paid to the managers of America's hot-shot funds typically equals 10 or more times the income of the average American. Unfortunately, as you'll see, they still lost a lot of their investors' money.

By comparison, all eight Lazy Portfolios are already sporting positive average annual returns on a 5-year basis. Plus they also beat all six of the popular actively managed funds on 1-year and 3-year average returns. I repeat: All eight Lazy Portfolios are outperforming every one of these popular actively managed funds. Apparently these actively managed funds exist for only one reason … to make their managers rich, not their own investors.

First, notice that three of these actively managed funds barely matched the performance of the S&P 500 the past year. In addition, the other three underperformed the S&P 500 by three to seven percentage points. In short, even though we know that the average compensation of portfolio managers is often $400,000 to more than a $1 million, the hot-shot managers of these actively managed funds provided no value-added to their funds' performance. None! Conclusion: Their investors would be better off investing in unmanaged index funds.

Popular funds	1-year return	3-year annualized return	5-year annualized return
Fidelity Magellan	-33.5%	-9.78%	-3.51%
Dodge & Cox Stock	-29.4	-12.7	-2.82
Legg Mason Value	-28.2	-18.9	-10.4
Janus Fund	-25.8	-5.51	-2.02
American Funds Washington Mutual	-25.3	-8.53	-2.32
Baron Growth	-25.2	-7.83	0.54
S&P 500	-26.2	-8.22	-2.24

As of June 30, 2009

Now, let's compare the performance of those six actively-managed funds to the performance of our eight Lazy Portfolios as of midyear 2009. Notice that all eight Lazy Portfolios beat the benchmark S&P 500 across the board for all three time periods. Yes, the market was in negative territory the past few years, but still all eight Lazy Portfolios outperformed each of the six actively-managed funds.

Lazy Portfolio	Number of funds	1-year return	3-year annualized return	5-year annualized return
Aronson Family	11	-18.7%	-3.06%	2.76%
Fund Advice	11	-15.8	-2.18	3.12
Smart Money	9	-15.9	-3.70	1.58
Coffeehouse	7	-15.0	-3.69	1.46
Yale U.	6	-21.8	-5.02	1.72
No-Brainer	4	-19.8	-4.74	1.08
Margaritaville	3	-19.8	-3.03	2.26
Second-Grader's	3	-24.3	-6.07	0.68
S&P 500		-26.2	-8.22	-2.24

As of June 30, 2009

These are midyear numbers. You can also find automatic daily updates at MarketWatch.com/lazyportfolio.

Here's why Lazy Portfolios are a winning strategy. It's based on the Nobel Prize-winning Modern Portfolio Theory: Simple, well-diversified portfolios of three to 11 low-cost, no-load index funds that require no active trading, no management. You let them do the work passively without tinkering with allocations. Just add new money from your regular savings to rebalance and build your retirement nest egg. (Warning: Wall Street bankers and brokers hate the Lazy Portfolio strategy because they can't get rich on index funds, no front-end commissions, no excessive annual management fees).

Six Rules For Success

Now here's how it works: Six simple rules guaranteed to help you diversify, lower risks, level out bull/bear cycles and generate returns that beat the indexes without buying high-expense actively managed funds or wasting your valuable time playing the market. Customize your own Lazy Portfolio following these six rules and you'll win. More important, you'll have lots of time left to enjoy what really counts, your family, friends, career, sports, hobbies, living.

• Market timing is for chumps and chimps. The market's random, irrational and unpredictable. You can't beat it. It loves humbling the mighty. Active trading makes no sense for America's 95 million passive investors, because fees, commissions and taxes kill returns. Besides, Prof. Terrance Odean's research proves: "The more you trade the less you earn". Back in the '90s a chimp throwing darts beat the stock market, made a monkey out of Wall Street. It's easy, you can too.


• Frugality, savings versus financial obesity. Tools like starting early, autopilot saving plans, dollar-cost averaging, frugal living and other tricks are familiar to long-term investors. Trust your frugality instincts— living below your means— it's a trait common among America's "millionaires next door."


• The explosive power of compounding. Albert Einstein, the jolly genius "Man of the Century," says that compounding is the world's most powerful force. Regular savings— expanding explosively, building on top of itself— is money power. Start early, with just $100 a month, you can retire a millionaire.


• Diversification— the lost art of being average. Don't be greedy, be average. If you put all your eggs in one basket, like speculative condo-flipping, and it goes belly-up, you end up with a burnt omelet. Dividend reinvestment guru Chuck Carlson's says: "Swing for singles". Just being average wins.
[[It wins in more ways than one. Statistics show that a highly variable fund will compound at a far lower rate than a less variable fund— even if the average (mean) annual increase/decrease is the same over the years. The compound return is what you wind up with after X years. : normxxx]]


• Buy (quality) and hold— and you'll never (have to?) sell. Ignore all the latest desperate Wall Street hype about "the death of buy and hold". They want to con you into paying their high fees and commissions. Warren Buffett's favorite holding period is "forever;" his best time to sell is "never!" So ignore Wall Street's "tips," do your homework, buy index funds with the idea you'll never sell, and win.


• Do it yourself: The Tortoise consistently beats the Hare. Think long-term: I remember Ric Edelman's amazing research: Millionaires spend less than three hours a month on personal finance, just six minutes a day. So, when you're ready, step up to the starting line and race like a tortoise. Discover how America's slowest, laziest portfolios get you on the road to retirement as a enlightened millionaire.

So that's our little crib sheet on how to build a lazy retirement portfolio. For more info, check out my book, the "Lazy Person's Guide to Investing." This method is so easy even a second-grader can grasp this stuff. In fact, one did, as you'll see at MarketWatch's Lazy Portfolios, where we automatically update all eight portfolios at the end of every trading day.

Do it and have fun knowing that you'll be beating the S&P 500 plus beating America's popular actively managed funds. But whatever you do, please don't spend too much time on investing, not just because it's a waste of time, but because there really are more important things in life: Loved ones, family, mom, dad, best friends, and doing stuff you love, that makes you happy.

[ Normxxx Here:  But there is one portfolio strategy that beats the "Lazy Portfolios" all hands down— it has earned +132.5% over the last 10 years (to 31 December 2008). In that time frame, the Nasdaq earned -28.0%, the S&P earned -13.2%, and the DJIA earned +17.9%  . Based on a "seasonal effect" that has consistently shown up in historical market statistics (back to the 17th century in England and in 36 of 37 countries contemporaneously), it has produced a stunning return of close to 200% (from 1950-1997 on a 'paper' retrospective, but prospectively over the last 10 years, as noted)— albeit, with only two trades a year, one sell in the Spring and one buy in the Fall. Although Sy Harding publishes a newsletter which provides the timing (and a great deal of other useful information, see http://www.streetsmartreport.com/ ), the method (and Sy's modifications— without which the method cannot best the costs and taxes involved in even just one purchase and sale a year) is freely described here: http://www.streetsmartreport.com/sts.html And they are quite simple enough to employ for one's self. Click Here, or on the image, to see a larger, undistorted image. Note: The above tabled effects are without Sy Harding's modifications, which add about another 100-200% to the return difference.]

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Comparing Job Losses And Investment Opportunities: Post WWII

Comparing Job Losses And Investment Opportunities In Post Wwii Recessions
Click here for a link to ORIGINAL article:

By Mike "Mish" Shedlock | 9 July 2009

Minyanville Professor Tony Dwyer posted an interesting chart yesterday about recessions and payrolls that is worth a look.


Click Here, or on the image, to see a larger, undistorted image.

Professor Dywer commented:

"The long awaited correction is finally showing up in the index prices. The equity market has been weakening internally since mid-April following a historic rally off the March low. I continue to expect the market to follow the 2002-2003 playbook that suggests the S&P 500 (SPX) should move back toward the mid-to-low 800s as the non-government credit markets continue to improve and hold the historic gains. "I've been waiting for the correction to become a more aggressive buyer as long as credit held the gains. The dramatic government intervention and historic improvement in credit, coupled with the cash buildup by investors should protect the downside and lead to a second half rally, while a weak economic recovery should keep the market from running too far ahead of itself into 2010. "While the correction may cause many to focus on the still problematic economic influences, the good news is the 2nd derivative improvement in just about all the macroeconomic indicators suggests the recession is very close to being over. "As an example, since the 1940's, every time the quarterly change in payrolls adjusted for the size of the labor force reaches a low and turns, it was the last quarter of the recession. The significant headwinds facing the consumer should limit the economic recovery, but there is sure to be a least a temporary recovery that should show up in higher stock prices by the end of the year. "I've been waiting for the correction to use the liquidity as an opportunity to become more aggressive and see no reason to change that plan. When the SPX moves back toward the mid-to-low 800s, I'll add to equity market exposure with a particular focus in Information Technology and Health Care."

Everyone it seems is waiting to buy the dip. Can it be that easy? Perhaps it can, as the herd is often right. However, recessions since 2000 don't exactly seem to be playing out like other post WWII recessions.

Please consider the following chart from Calculated Risk on Job Losses In Post WWII Recessions.


Click Here, or on the image, to see a larger, undistorted image.

The above chart shows that this recession is not comparable to other post WW2 downturns. (Indeed, neither are modern day payroll nor unemployment stats directly comparable with any of the data prior to 1990 [[guess which way they've been doctored, …er, 'adjusted'!?!: normxxx]])

Perhaps the recession is over soon, but given the shape of the curves above, can we expect a typical recovery in the stock market and/or the economy? There certainly may be a recovery that will show up in stock prices by the end of the year, but being sure of a rally is a bit overconfident. The bottom could indeed be in, even though it fundamentally does not feel like it should be. [[Well, we could always have a double dip, like 1980-82: normxxx]]

The model I think we may be following looks more like this.

Nikkei Japan Index 1980-Present


Click Here, or on the image, to see a larger, undistorted image.

Technically there is room for huge rallies, but there is also room for plenty of misery (for both bulls and bears). The key will be to stay nimble as the opportunities that present themselves may not follow traditional post WWII recovery patterns.

Mike "Mish" Shedlock

Dream Retirement: 50% Cheaper

Your Dream Retirement Just Got 50% Cheaper

By Dr. David Eifrig, Editor, Retirement Millionaire | 8 July 2009


Click Here, or on the image, to see a larger, undistorted image.

The big, white sign in front promised a free list of foreclosures. Early last month, I set off to explore the real estate market on Florida's Treasure Coast— specifically St. Lucie County— to see if it makes sense for my Retirement Millionaire readers… and perhaps myself. My first stop was the GMAC Real Estate office on Port St. Lucie Boulevard.

I walked in unannounced and asked the lady snapping her gum at the front desk for the promised foreclosures list. She said I had to meet with a salesperson first. Luckily, I drew Jim Smolinsky's straw. Jim's a laid-back middle-aged guy— his business card shows him in a tropical Tommy Bahama shirt. We talked for more than an hour.

"Dave, right after Hurricane Wilma in 2005, there were no homes under $200,000 for sale. Rents were $1,400 a month for a three-bedroom two-bath home. Today, there are thousands of properties under that price! And rents are plummeting." Just four years ago, Port St. Lucie was the fastest-growing area in the country.

It's no wonder… this place truly is a slice of heaven— a golf-and-retirement community 45 minutes north of West Palm Beach. After visiting the area, I can tell you this: If you've suffered the past two years watching your investment portfolio collapse along with your dreams of a Florida retirement, you can stop worrying: Your dream retirement just got 50% cheaper.

Florida has always been a mecca for retirees. The warm weather and zero state income tax have drawn folks for generations. But during the housing bubble of the 2000s, growth in places like Port St. Lucie spun out of control.

Between 2000 and 2005, the population of Port St. Lucie exploded from 88,769 people to 151,391. Not surprisingly, the median home price shot from $88,700 to about $235,900. Since then, housing prices have collapsed, falling nearly in half to $118,500.

That kind of whiplash price drop always perks up the bargain hunter in me. Of the 4,035 properties on the local market, 992 were "short sales" (when the bank agrees to let the owner sell the house at less than the outstanding mortgage's value) and 183 were foreclosed properties. Think about it… nearly a third of the sellers are desperate to unload their properties.

All told, during three days in St. Lucie County, I saw more than 250 properties. Prices ranged from $9,000 for a three-bedroom/one-bath dump up to a three-bedroom/two-bath McMansion on the golf course for $604,900. Of the 10 cheapest places, five were built in the 1950s. These teardown shacks would provide lots of fun for a hardcore do-it-yourselfer with a wrecking ball— but not my sort of thing.

Of the 10 most expensive, five were built in 2006. I focused on homes in the $120,000-$160,000 range because they seemed to offer the best blend of value and newness in neighborhoods where I'd actually live. Whether you want a place near water or close to the PGA Village and shopping malls, foreclosures, short sales, and outright sales abound. For example, if you like golf as much as I do, there's a two-bedroom/two-bath townhome next a public golf course on well-manicured grounds for only $120,000.

If you have cash and are thinking about a second home, you can find some great deals on single-family houses. In many cases, these newer homes are selling for less than $70-$75 per square foot. To compare, Miami is starting to see bids at $200 a square foot for high-rise condos. And don't forget, "first-time" homebuyers (meaning you haven't owned a home in the past three years… hmm… that's some good government doublespeak) can get a tax credit of $8,000.

So… how much will it actually cost? Well, here's what a $200,000, 2,300-square-foot home would cost in the PGA Village, within a short wedge shot of one of the fairways, with $40,000 down. Port St. Lucie is a great spot for retirees. Florida has no income tax, the beach, and the 'homestead exemption'— which allows you to keep your house if you get into legal trouble.

Item Monthly Cost Mortgage $900 ($160,000 for 30 years at 5.375%) Taxes $112 Insurance $125 Association Dues $250-$300 Total $1,412

But the main thing I'd like for you to take away from what I found on my Treasure Coast trip is that things are tough in the real estate business right now… which makes owning a slice of retirement heaven much cheaper today than it was three years ago. If you've ever considered moving to Florida, it's now more affordable than you thought.

Here's to our health, wealth, and a great retirement.

Good investing,

Dr. David Eifrig

P.S. The real estate collapse of the past few years drove home a major point for many people: Retirement in America has changed in a big way. If you're counting on giant institutions (like the government and insurance companies) to take care of you… good luck. But if you're willing to take off the blinders of institutional thinking, you can (legally) "steal" back your retirement, no matter what your current situation. I've compiled plenty of details on how you can get started immediately. Click here to learn more…

US Lurching Towards 'Debt Explosion'

We Just Can't Afford It!

By Howard Gold | 7 July 2009

How bad is the nation’s fiscal crisis? Worse than you think. Two reports published last month underscore how grim the outlook is. A report by the liberal Brookings Institution’s respected economist William G. Gale, along with Alan J. Auerbach of UC Berkeley, describes the situation in nearly apocalyptic terms. "The fiscal-year 2009 budget is enormous; the ten-year projection is clearly unsustainable; and the long-term outlook is dire and increasingly urgent," the two economists write.

And the Congressional Budget Office, a nonpartisan watchdog, also sounds the alarm: "The federal budget is on an unsustainable path— meaning that federal debt will continue to grow much faster than the economy over the long run," its June report reads. "Large budget deficits would reduce national saving, leading to more borrowing from abroad*[!?!] and less domestic investment, which in turn would depress income growth in the United States," the report continues. "Over time, [it] would seriously harm the economy."

How much money are we talking about? This year, the US deficit may hit $1.7 trillion, 12% of gross domestic product, the highest percentage since World War II. And Gale and Auerbach project annual deficits averaging $1 trillion a year until 2019. The total estimated ten-year deficit: a whopping $10 trillion. Although the two economists expect a recovery and the end of some crisis-relief programs to cut the deficit to 4.8% of GDP by 2012, they expect that percentage to move up again to 6.4% of GDP.

In the very long run, Social Security and especially Medicare will consume more and more resources. The CBO projects Medicare and Medicaid will account for 80% of the growth in spending between now and 2035, while Social Security will represent the other 20%. Right now, however, the main culprit is the thoroughly reckless policies of the Bush Administration and the equally reckless plans President Obama is currently cooking up— and the Republican and Democratic Congresses that approved them, or soon will.

Remember, back in 2000, the CBO was projecting $5.6 trillion in surpluses over this decade. The dot.com bust, the recession, and September 11th put an end to that. But policy decisions made the real difference. David Leonhardt of the New York Times analyzed ten years of CBO reports and found that 37% of the swing from surplus to deficits can be explained by the recessions of 2001 and this one. Another 33% came from "new legislation signed by Mr. Bush."

That includes the Medicare Prescription Drug Benefit and No Child Left Behind. President Obama’s continuation of other Bush programs [[the very first President to cut taxes in a time of not merely one, but 2½ wars: normxxx]], like the lion’s share of the tax cuts, will account for another 20% of the change. (That includes our declining military presence in Iraq and stepped-up involvement in Afghanistan.) And only 10% is from new legislation proposed by the current president— the stimulus bill and his agenda for energy, health care, and education.

In fact, says Diane Lim Rogers, chief economist of The Concord Coalition, a nonpartisan group that supports responsible fiscal policy, "the number-one most expensive item in the Obama administration is the extension of the Bush tax cuts." The president made repeal of the tax on top earners a centerpiece of his campaign while repeatedly pledging not to raise taxes on the middle class. But rescinding the cuts for the top tax bracket will save us "only" $600 billion; $2 trillion worth of tax cuts continue for everybody else, and they will cause the most red ink of all, Rogers says.

It’s now clear that extraordinarily low interest rates, financial shenanigans on Wall Street, and most of all, the housing bubble created the 2003-2007 recovery [[such as it was: normxxx]]. With subpar employment and GDP growth, cuts in marginal tax rates clearly had little impact this time around— except to make the deficit balloon. Yet it would seem to be politically impossible and economically inadvisable to let those cuts expire for everyone by the end of 2010, when we might just be emerging from the recession and joblessness may still be high.

I do see signs, however, that the American people are coming to grips with reality. Some 52% now think the deficit is a serious problem; during the campaign only 2% thought it was our most important economic problem. That’s a step forward, but it’s not enough. Truth is, we simply can’t afford any new domestic programs until we figure out how to pay for the ones we’ve got.

That includes universal health care coverage, education spending, and cap and trade. Heck, we can’t afford the current Medicare, Medicaid, and Social Security plans. If we continue on this path, we’ll need to seriously consider means testing people to make sure only the needy get access to these benefits— we may need to ration medical care as well.

Someone may have to tell families that their 85-year-old father is not going to get extraordinary care unless they’re willing to pay for it themselves (or they have the insurance coverage to do it). Somebody may have to tell Social Security recipients that they can’t get [early] benefits until they’re, say, 65. And someone may have to tell the public that if they want government services, they’re going to have to pay higher taxes— or expect fewer benefits.

"Doing nothing is not an option," writes Rogers on her EconomistMom blog. "Legislation must ultimately be adopted that raises revenue or reduces spending or both". Newsweek columnist Robert J. Samuelson writes , "The system has promised more than it can realistically deliver. We are borrowing not to finance investment in the future but to pay for today's welfare— present consumption. … The sensible thing would be to decide which forms of public welfare are needed to protect the vulnerable and to begin paring others.

The American people have been living in a dream world. They have just begun to realize that they can’t have a 5,000-square-foot McMansion unless their reliable income and/or net worth are many times what it actually is— without credit! And, are they ready to accept that they’ll have to pay more to get their trash collected and their kids educated, too?

Until we all grow up and accept the fact that there are limits to everything— including satisfying our wants and desires— we can’t expect craven politicians to do anything different from what they’re doing now. If we don’t change and we don’t pressure our elected officials to do the same, we might as well start firing up the printing presses now, because we’re going to need a lot more dollars to fill the deepening hole. [[And, remember, it's the middle-class that gets wiped out in a hyper-inflation!: normxxx]]

*But our overseas lenders have long ago gotten wise to us!

US Lurching Towards 'Debt Explosion'; Long-Term Interest Rates On Course To Double

By Philip Aldrick, Banking Editor, Telegraph, UK | 6 July 2009

The US economy is lurching towards crisis with long-term interest rates on course to double, crippling the country’s ability to pay its debts and potentially plunging it into another recession, according to a study by the US’s own central bank. In a 2003 paper, Thomas Laubach, the US Federal Reserve’s senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt. Applying his assumptions to the recent spike in the US fiscal deficit and national debt, he found that long-term interests rates will double from their current 3.5%.

The impact would be devastating— making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research, called a "debt explosion". Mr Laubach’s study has implications for the UK, too, as public debt is soaring here also. But, a US crisis would have implications for the rest of the world, in any case.

Using historical examples for his paper, "New Evidence on the Interest Rate Effects of Budget Deficits and Debt", Mr Laubach came to the conclusion that "a percentage point increase in the projected deficit-to-GDP ratio raises the 10-year bond rate expected to prevail five years into the future by 20 to 40 basis points, a typical estimate is about 25 basis points". The US deficit has blown out from 3% to 13.5% in the past year but long-term rates are largely unchanged. Assuming Mr Laubach’s "typical estimate", long-term rates have to climb 2.5 percentage points.

He added: "Similarly, a percentage point increase in the projected debt-to-GDP ratio raises future interest rates by about 4 to 5 basis points." Economists are predicting a wide range of ratios but Mr Congdon said it was "not unreasonable" to assume debt doubling to 140%. At that level, Mr Laubach’s calculations would see long-term rates rise by 3.5 percentage points.

The study is damning because Mr Laubach was the Fed’s economist at the time, going on to become its senior economist between 2005 and 2008, when he stepped down. As a result, the doubling in rates is the US central bank’s own prediction. Mr Congdon said the study illustrated the "horrifying" consequences for leading western economies of bailing out their banks and attempting to stimulate markets by cutting taxes and boosting public spending. He said the markets had failed to digest fully the scale of fiscal largesse and said "current gilt yields [public debt] are extraordinarily low given the size of deficits".

Should the cost of raising or refinancing public debt in the markets double, "the debt could just explode", he said, adding that it would come to a head in "five to 10 years". The only way out of this mess is to get back to basics, which we are, by force of economic necesity doing. However Fiscal Discipline will come only when our Politicians realize that our country will not survive without "Trust in God" and stop putting all your trust in Government or the "Arm of Flesh".

Dead Broke!?!

We Just Can't Afford It!

By Howard Gold | 7 July 2009

How bad is the nation’s fiscal crisis? Worse than you think. Two reports published last month underscore how grim the outlook is. A report by the liberal Brookings Institution’s respected economist William G. Gale, along with Alan J. Auerbach of UC Berkeley, describes the situation in nearly apocalyptic terms. "The fiscal-year 2009 budget is enormous; the ten-year projection is clearly unsustainable; and the long-term outlook is dire and increasingly urgent," the two economists write.

And the Congressional Budget Office, a nonpartisan watchdog, also sounds the alarm: "The federal budget is on an unsustainable path— meaning that federal debt will continue to grow much faster than the economy over the long run," its June report reads. "Large budget deficits would reduce national saving, leading to more borrowing from abroad[!?!] and less domestic investment, which in turn would depress income growth in the United States," the report continues. "Over time, [it] would seriously harm the economy."

How much money are we talking about? This year, the US deficit may hit $1.7 trillion, 12% of gross domestic product, the highest percentage since World War II. And Gale and Auerbach project annual deficits averaging $1 trillion a year until 2019. The total estimated ten-year deficit: a whopping $10 trillion. Although the two economists expect a recovery and the end of some crisis-relief programs to cut the deficit to 4.8% of GDP by 2012, they expect that percentage to move up again to 6.4% of GDP.

In the very long run, Social Security and especially Medicare will consume more and more resources. The CBO projects Medicare and Medicaid will account for 80% of the growth in spending between now and 2035, while Social Security will represent the other 20%. Right now, however, the main culprit is the thoroughly reckless policies of the Bush Administration and the equally reckless plans President Obama is currently cooking up— and the Republican and Democratic Congresses that approved them, or soon will.

Remember, back in 2000, the CBO was projecting $5.6 trillion in surpluses over this decade. The dot.com bust, the recession, and September 11th put an end to that. But policy decisions made the real difference. David Leonhardt of the New York Times analyzed ten years of CBO reports and found that 37% of the swing from surplus to deficits can be explained by the recessions of 2001 and this one. Another 33% came from "new legislation signed by Mr. Bush."

That includes the Medicare Prescription Drug Benefit and No Child Left Behind. President Obama’s continuation of other Bush programs [[the very first President to cut taxes in a time of not merely one, but 2½ wars: normxxx]], like the lion’s share of the tax cuts, will account for another 20% of the change. (That includes our declining military presence in Iraq and stepped-up involvement in Afghanistan.) And only 10% is from new legislation proposed by the current president— the stimulus bill and his agenda for energy, health care, and education.

In fact, says Diane Lim Rogers, chief economist of The Concord Coalition, a nonpartisan group that supports responsible fiscal policy, "the number-one most expensive item in the Obama administration is the extension of the Bush tax cuts." The president made repeal of the tax on top earners a centerpiece of his campaign while repeatedly pledging not to raise taxes on the middle class. But rescinding the cuts for the top tax bracket will save us "only" $600 billion; $2 trillion worth of tax cuts continue for everybody else, and they will cause the most red ink of all, Rogers says.

It’s now clear that extraordinarily low interest rates, financial shenanigans on Wall Street, and most of all, the housing bubble created the 2003-2007 recovery [[such as it was: normxxx]]. With subpar employment and GDP growth, cuts in marginal tax rates clearly had little impact this time around— except to make the deficit balloon. Yet it would seem to be politically impossible and economically inadvisable to let those cuts expire for everyone by the end of 2010, when we might just be emerging from the recession and joblessness may still be high.

I do see signs, however, that the American people are coming to grips with reality. Some 52% now think the deficit is a serious problem; during the campaign only 2% thought it was our most important economic problem. That’s a step forward, but it’s not enough. Truth is, we simply can’t afford any new domestic programs until we figure out how to pay for the ones we’ve got.

That includes universal health care coverage, education spending, and cap and trade. Heck, we can’t afford the current Medicare, Medicaid, and Social Security plans. If we continue on this path, we’ll need to seriously consider means testing people to make sure only the needy get access to these benefits— we may need to ration medical care as well.

Someone may have to tell families that their 85-year-old father is not going to get extraordinary care unless they’re willing to pay for it themselves (or they have the insurance coverage to do it). Somebody may have to tell Social Security recipients that they can’t get [early] benefits until they’re, say, 65. And someone may have to tell the public that if they want government services, they’re going to have to pay higher taxes— or expect fewer benefits.

"Doing nothing is not an option," writes Rogers on her EconomistMom blog. "Legislation must ultimately be adopted that raises revenue or reduces spending or both". Newsweek columnist Robert J. Samuelson writes , "The system has promised more than it can realistically deliver. We are borrowing not to finance investment in the future but to pay for today's welfare— present consumption. … The sensible thing would be to decide which forms of public welfare are needed to protect the vulnerable and to begin paring others.

The American people have been living in a dream world. They have just begun to realize that they can’t have a 5,000-square-foot McMansion unless their reliable income and/or net worth are many times what it actually is— without credit! And, are they ready to accept that they’ll have to pay more to get their trash collected and their kids educated, too?

Until we all grow up and accept the fact that there are limits to everything— including satisfying our wants and desires— we can’t expect craven politicians to do anything different from what they’re doing now. If we don’t change and we don’t pressure our elected officials to do the same, we might as well start firing up the printing presses now, because we’re going to need a lot more dollars to fill the deepening hole. [[And, remember, it's the middle-class that gets wiped out in a hyper-inflation!: normxxx]]

We're In The Middle Of A Crash

'We're In The Middle Of A Crash' Predicted By "The Black Swan"
There Was An International Financial Crisis In 2007 And 2008

By Nassim Taleb | 6 July 2009

See video:



The financial system is crashing and action must be taken by the US government to convert debt into equity to produce a more stable environment, Nassim Taleb, author of "The Black Swan," told CNBC Thursday. "You may have green shoots, whatever you want to call them, you may have temporary relief, but you are still in a world that's breaking," Taleb said on "Squawk Box."

Anything that's as fragile as the current international and U.S. financial system will eventually crash, he said. "We're in the middle of a crash," Taleb said. "So if I'm going to forecast something, it is that it's going to get worse, not better". The government needs to deleverage debt and not try stimulus packages that will inflate assets, he said. [[You can't blow up a broken balloon again; FDR tried it and failed.: normxxx]]

IMF: International Mortgage Reset Chart

U.S. Mortgage Reset Chart

"What makes me very pessimistic is not seeing any leadership or awareness on the parts of governments on what has to be done, which is deleverage $40 to $70 trillion," Taleb said. [[To staunch the imminent huge second wave of foreclosures.: normxxx]] "The monkey on our back is debt," he added. As an example, Taleb said banks should not be sending demands for larger and larger sums from homeowner in arrears on their mortgage. Instead the bank should offer to lower the monthly payments in return for part-ownership of the property. [[Good idea, BUT, in our derivative world, who makes up the difference to the end lenders!?!— who are mostly not the banks?: normxxx]]

"People would be able to start from scratch on a healthy basis. You don't want to wait for foreclosure," he said. The Obama administration's attempts to fight the financial crisis with more cash is like "treating a bad tooth with Novocain instead of a root canal". The main problem is the level of debt, and Taleb compared the authorities' efforts with those of a not very skilled pilot who is trying to land a Concorde on a narrow strip, between an ocean of deflation and a mountain of hyperinflation.

"These people failed us before, they're going to fail us again," Taleb told CNBC. "They tell the banks to 'lend more but with less leverage'" and expect people to go out and "consume while unemployment is rising", he added. "The way to restart everything is restructuring, conversion of debt into equity, convince people that debt is not good." … "Do not delay the root canal. Do not do 'piecemeal' solutions to a problem that is fundamental. The solution is there, convert debt to equity. Usually it happens with Chapter 11, let's do it faster, and across the board," Taleb concluded.

Slideshow: The 15 U.S. States with the Worst Expected Budget Gaps

Slideshow: The World's Biggest Debtor Countries

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Yes Virginia, There Was An International Financial Crisis In 2007 And 2008

By Brad Setser | 23 June 2009

Now that the markets have lost a bit of their froth, it seems fitting to note just how sharply trade— and private financial flows— have contracted over the past year. The US Q1 balance of payments data is rather stunning. (Trade— as we all know— contracted far more rapidly during this cycle than in the past.)


Click Here, or on the image, to see a larger, undistorted image.

But the fall in private financial flows— outflows as well as inflows— has been even sharper than the fall in trade flows. US private investment in the rest of the world rebounded a bit in the first quarter, but private demand for US financial assets remained in the doldrums. Private investors were still pulling funds out of the US in the first quarter.

A close examination of the graph indicates that demand for US financial assets by private investors abroad actually peaked in the second quarter of 2007— a peak that came after gross private flows (inflows as well as outflows) rose strongly in 2005 and 2006. That surge was— in my view— linked to the chain of risk associated with a world where central banks took the currency risk associated with financing the US external deficit and private intermediaries took the credit risk associated with financing ever more indebted US households. Any interpretation of what caused the crisis has to explain this surge. But any interpretation of the crisis also needs to explain why US imports and exports continued to rise— and the US trade and current account deficit remained large— even after private inflows collapsed.

I suspect that part of the answer is that a lot of private inflows were linked to private outflows— as special investment vehicles operating in, say, the US could only buy long-term US mortgage bonds if someone in the US bought their short-term paper. The fact that private outflows collapsed along with private inflows meant that net private flows didn’t fall at the same rate. Indeed, at times— notably in Q4 2008— the fact that US investors pulled funds out of the rest of the world faster than foreign investors pulled funds out of the US provided the US with a significant amount of net financing.

And part of the answer is that private investors never were the only source of financing for the US current account deficit. Strong central bank demand— especially in late 2007 and early 2008— offset the fall in private flows. One thing though is sure: the scale of the collapse in private financial flows during this crisis is entirely unprecedented. There were a few instances in the past when private flows (excluding flows into Treasuries) were slightly negative. But outflows of 5% of GDP in a quarter are entirely unprecedented. And now that the US data has been revised to reflect the survey, adding private purchases of Treasuries back in doesn’t change all that much.

Net private demand for long-term US financial assets— that is purchases of US securities and foreign direct investment in the US, net of US purchases of foreign securities and US direct investment abroad— has been weak for some time now. There is more to say on the details of the balance of payments data, but I’ll live it for another post.


Click Here, or on the image, to see a larger, undistorted image.

The Lessons Of 1937

The Lessons Of 1937
Policymakers Must Learn From The Errors That Prolonged The Great Depression

By Christina Romer, From The Economist Print Edition | 18 June 2009

Christina Romer is the chairwoman of Barack Obama's Council of Economic Advisers and a scholar of the Depression.

At a recent congressional hearing I cautiously noted some "glimmers of hope" that the economy could stabilise and perhaps start to rebound later in the year. I was asked if this meant that we should cancel much of the remaining spending in the $787 billion American Recovery and Reinvestment Act. I responded that the expected recovery was both months away and predicated on Recovery Act spending ramping up greatly. Only later did it hit me that I should have told the story of 1937.

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.

Also important was an accidental switch to contractionary monetary policy. In 1936 the Federal Reserve began to worry about its "exit strategy". After several years of relatively loose monetary policy, American banks were holding large quantities of reserves in excess of their legislated requirements. Monetary policymakers feared these excess reserves would make it difficult to tighten if inflation developed or if "speculative excess" began again on Wall Street.

In July 1936 the Fed’s board of governors stated that existing excess reserves could "create an injurious credit expansion" and that it had "decided to lock up" those excess reserves "as a measure of prevention". The Fed then doubled reserve requirements in a series of steps. Unfortunately it turned out that banks, still nervous after the financial panics of the early 1930s, wanted to hold excess reserves as a cushion. When that excess was 'regulated away', they scrambled to replace it by reducing lending. According to a classic study of the Depression by Milton Friedman and Anna Schwartz, the resulting monetary contraction was a central cause of the 1937-38 recession.

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently.

If the government withdraws support too early, a return to economic decline or even panic could follow. In this regard, not only should we not prematurely stop Recovery Act spending, we need to plan carefully for its expiration. According to the Congressional Budget Office, the Recovery Act will provide nearly $400 billion of stimulus in the 2010 fiscal year, but just over $130 billion in 2011. This implies a fiscal contraction of about 2% of GDP.

If all goes well, private demand will have increased enough by then to fill the gap. If that is not the case, broad policy support may need to be sustained somewhat longer. Perhaps a more fundamental lesson is that policymakers should find constructive ways to respond to the natural pressure to cut back on stimulus. For example, the Federal Reserve’s balance-sheet has more than doubled during the crisis, drawing considerable attention.

Monetary policymakers have made it clear that they believe continued monetary ease is appropriate. Moreover, the Fed’s credit programmes are to some degree self-eliminating: as demand for its special credit facilities shrinks, so will its balance-sheet. But now may also be a sensible time to grant the Fed additional tools to help its balance-sheet contract once the economy has recovered.

Some have suggested that the Fed be authorised to issue debt, as many other central banks do. This would enhance its ability to withdraw excess cash from the financial system. Granting such additional tools now could provide confidence that the Fed will be able to respond to inflationary pressures, without it having to create that confidence by actually tightening prematurely.

Fiscal Health Check

Now is also the time to think about our long-run fiscal situation. Despite the large budget deficit President Obama inherited, dealing with the current crisis required increasing the deficit substantially. To switch to austerity in the immediate future would surely set back recovery and risk a 1937-like recession-within-a-recession. But many are legitimately concerned about the longer-term budget situation.

That is why the president has laid out a plan to shrink the deficit he inherited by half and has repeatedly emphasised the need to reduce the long-term deficit and put the debt-to-GDP ratio on a declining trajectory. In this regard, health-care reform presents a golden opportunity. The fundamental source of long-run deficits is rising health-care expenditures. By coupling the expansion of coverage with reforms that significantly slow the growth of health-care costs, we can dramatically improve the long-run fiscal situation without tightening prematurely.

As someone who has written somewhat critically of the short-sightedness of policymakers in the late 1930s, I feel new humility. I can see that the pressures they were under were probably enormous. Policymakers today need to learn from their experiences and respond to the same pressures constructively, without derailing the recovery before it has even begun.


Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A 20-Year Bear Market?

Outside The Box

By John Mauldin | 30 June 2009

Long time readers know that I am a huge fan of the work of Neil Howe. His book, The Fourth Turning, written with William Strauss, was one of the seminal pieces of my reading over the last 30 years. [[Earlier, they also wrote Generations: The History of America's Future, 1584 to 2069 : normxxx]] And it has turned out to be stunningly prophetic. Uncomfortably so. A roughly 80 year cycle (±2 to 4 years) has been repeating itself for centuries in the Anglophile world, broken up into four 'generations' or 'turnings'. We have begun what Howe called many, many years ago The Fourth Turning.

Neil Howe is the co-author, with the late William Strauss, of a number of seminal works on the impact of 'generations' on cycles of history. Howe is a founding partner of LifeCourse Associates (lifecourse.com) which provides research to institutions looking to capitalize on generational research.

The June 2009 edition of The Casey Report, the flagship publication of Casey Research, featured a comprehensive 23 page interview with Neil Howe as well as suggestions on how to position your portfolio to profit during a Fourth Turning crisis. I persuaded my friend David Galland to at least summarize it for my Outside the Box this week, and he graciously did so. David is the managing editor of The Casey Report and has had a long career in the financial services industry; as a founding partner of the successful Blanchard Group of Mutual Funds and, before joining Casey Research, as a founding partner of EverBank, one of the big success stories in independent online banking.

Casey Research is offering readers of Outside the Box the opportunity to read the full edition of The Casey Report featuring the Howe Interview, and receive the publication for the next three months with a 100% satisfaction guarantee. For details click here

I trust you will find this week's Outside the Box to be helpful. The more things change…….

John Mauldin, Editor
Outside the Box
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

A 20-Year Bear Market?

By David Galland, Casey Research | 30 June 2009

In November of 1997, my partner and co-editor of The Casey Report, Doug Casey, wrote an article (annotated in 2005) titled "Foundations of Crisis," which leaned heavily on the research of Neil Howe and the late William Strauss. Howe and Strauss have written many books on how generations determine the course of history and how they will shape America's future. Their forecasts on a wide variety of indicators have turned out to be amazingly accurate.

They were among the first to predict (back in the late 1980s) the rise of Boomer-driven culture wars and the simultaneous rise of Gen-X-driven free agency and distrust of government. And they were completely alone back then in predicting, for the post-X "Millennial Generation" (a label they coined), a decline in youth crime and risk taking and an increase in youth civic engagement that would first become apparent around the year 2000. Guess what? For the last ten years, everyone has been noticing exactly these trends among teens and 20-somethings.

Howe and Strauss also made extensive predictions, based on 'generational aging', on how America's entire social mood would likely change, in dramatic fashion, during our current 2000-2010 decade. To quote Doug's prescient 1997 article, which was reprinted in Outside the Box late last year (2008):

"[1997]… an excellent case can be made that the U.S. is approaching another time of secular crisis, a Fourth Turning, with an expected due date of 2005— seven years from now— plus or minus a few years in either direction. "The Stamp Acts catalyzed the American Revolution, the election of Lincoln catalyzed the Civil War, the Crash of '29 catalyzed the Depression/WW II era. What might precipitate the elements now floating in solution? The answer is practically any random event that's sufficiently traumatic. Any of the [premises] of current disaster/action novels and movies will do nicely. "Perhaps the accidental or intentional release of a super plague vector. The crashing of an airliner into the Capitol during a joint session [[remember, this was written in 1997! : normxxx]]. An all-out assault on the IRS computers by an armed group— or perhaps the computers just melting down due to the Year 2000 Problem. Perhaps a financial disaster that cascades into the Greater Depression. In any of these, or a hundred other scenarios, the federal government would almost certainly act precipitously and with a heavy hand, which would bring on a whole other set of consequences. "There's no way of telling where the Crisis will lead, or how it will end. That's going to depend not only on exactly who's in control, but what they do, who they're up against, and a hundred other variables we can't even anticipate. "One thing that seems certain is that real crisis brings out strong leadership. Because of its age and size, it will come from the Boomer generation, and it will be in the mold of Roosevelt or Lincoln— both very dangerous precedents. The boomers in elderhood will be dogmatic, harsh, puritanical, and quite willing to burn down the barn in order to destroy whatever rats they see. [[ We lucked out(?) by finally skipping the boomers for a gen-Xer! Clinton and 'w' were the boomers— who left us with a wrecked economy, 2½ wars, a severely compromised constitution, …: normxxx]] Admix that attitude to a time resembling the Revolution, the Civil War, or WW II, overlain with today's ethnic strife, urbanization, financial overextension, and powerful, compact new weaponry in the hands of foreign fanatics out to teach the Great Satan a lesson and it's a real witch's brew."

As eye-opening as Doug's predictions were, they brought us only to the onset of the current crisis. Consequently, we thought it both timely and important to check back with the source of much of the research he relied on. And so it was that I spent several hours talking with Neil Howe, co-author of the seminal work on generational cycles, The Fourth Turning, and, just recently, the subject of the DVD "The Winter of History". Howe is not just an historian, but also a Washington DC-based economist and demographer. While our conversation covered a great many topics, the overriding focus was on how things are likely to unfold from here.

Many bullish readers won't be thrilled to hear Howe's latest findings about the future, but given his predictive track record, dismissing them out of hand could be a costly mistake. The summary outlook, according to Howe, is that we are in the very early stages of a 20-year period of economic and institutional upheaval— an era denominated by a crisis during which we'll likely witness the tearing down and reconstruction of many aspects of society as we know it.

As individuals, understanding Howe's views and taking some reasonable precautions makes a lot of sense. As investors, those views also have the potential to make us a lot of money. Following is my high-level recap of my long conversation with Neil Howe, along with some general thoughts on the investment implications of a 20-year bear market.

Remember the Sixties?

If you're old enough— or possess even a rudimentary sense of history— think back to the 1950s, with roller-skating waitresses, crew cuts, and nuclear families of the sort represented by the iconic Leave it to Beaver. Fathers worked, while most mothers stayed home. Life had a certain predictable quality and, as far as anyone knew, would continue along the same lines until the end of time.

But then something happened… the 1960s. Literally no one saw it coming. It was as if someone had flipped a switch that electrified America and, quickly, the world. Most everything changed, and a society accustomed to conformity was blown away with a fierce individualism expressed with long hair, sex, drugs, and rock and roll, topped off with civil disobedience and bloody riots in the streets. [[Not to mention the start of the Viet Nam war…: normxxx]]

What happened?

According to Neil Howe, in the mid-1960s, generational change pushed society around a dramatic corner as idealistic, individualistic young Baby Boomers (born 1943 to 1960) rebelled against the midlife leadership of their G.I. Generation parents (born 1901 to 1924). These 'periods of transitions' are part of a larger cyclical pattern made up of four distinct eras, or "Turnings," each lasting approximately 20 years. It can be helpful to think of the four turnings as you might think of the four seasons, repeating predictably in their own natural rhythm.

A full cycle of turnings takes place over a period of about 70 to 90 years— roughly the span of a long human life. A new turning begins as a new youth generation comes of age, bringing a new social ethic that compensates for the excesses of the midlife generation then in power. While we don't have the space here to go into the full details of Howe's research [[see the references above: normxxx]], it's important to the topic at hand that we quickly recap the Four Turnings.

The First Turning is referred to by Howe as a High. As this follows a period of crisis, one of the hallmarks of a First Turning is a heightened sense of community and collective optimism, driven in part by the fact that the society has just come through a difficult and challenging time. Consequently, during First Turnings, societal institutions tend to be strong while individualism is weak. The post-World War II "High" of the mid-1940s through early '60s is the most recent example of a First Turning.

The Second Turning, called an Awakening, typically starts out feeling like the high tide of a High, with signs of progress and prosperity everywhere. But just as everything seems to be going along swimmingly, large swaths of society begin to chaff under the 'social conformity' of the High, beginning to gravitate to more 'individualistic' pursuits and demanding that their 'personal interests' come first. You may recognize the "Consciousness Revolution" of the mid-1960s through early 1980s, correctly, as the Second Turning.

Next up, the Third Turning, which Howe calls an Unraveling, is much the opposite of a High. To wit, individualism dominates, while institutions are increasingly weak and discredited. Quoting Howe on the Unraveling…

"This is a time when social authority feels inconsequential, the culture feels exhausted, and people feel bewildered by the number of options available to them. It is a time of celebrity circuses and a tremendous amount of freedom and creativity in our personal lives, but very little sense of public purpose. "The most recent Third Turning began in the mid-'80s with Morning in America, and continued through the '90s. Previous periods of Unraveling in American history were also decades of cynicism and bad manners. Think of the 1920s, the 1850s, the 1760s. And history teaches us that the Third Turnings inevitably end in Fourth Turnings."

Finally, there is the Fourth Turning, called a Crisis. The recent Third Turning appears to be winding down, and we are currently on the cusp of a Fourth Turning. This is a time of great turmoil, when society's basic institutions are torn down and rebuilt, and seemingly insurmountable problems are addressed. During Fourth Turnings, America engages in a struggle for its very survival and redefines its identity as a nation. Large wars are often a part of this process. The American Revolution, Civil War, and the Great Depression/World War II were all features of past Fourth Turnings. [[Think of 1920 as 'similar to' 2000 (including the severe recession of 1920-21)…: normxxx]]

In sum, Howe's research has shown that, with remarkable predictability, history is not a straight line extending toward a better and brighter (or increasingly awful) future, but rather a repeating cycle of the four distinct social eras. These four turnings have recurred with remarkable consistency throughout Anglo-American history, as Neil Howe outlines at length in Generations and The Fourth Turning. It is therefore no accident that America has experienced great cataclysms or "Crises" about every 80 years. Travel back eighty years from Pearl Harbor Day, and you land in the middle of the Civil War. Eighty years before that takes you to the Revolutionary War. If the rhythms of history hold, America is now poised to enter another Fourth Turning. [[And think of 2009 as approximately 1929±1 or 2 years!: normxxx]]

Bad News, Potentially Good News

You don't need me to tell you that the United States and in fact the world are now facing a plethora of intractable problems. The world's former powerhouse economy, the U.S., is now the world's largest debtor nation— and by a huge margin. The nation has $trillions in unpayable liabilities coming due on Social Security and Medicare, to name just two of many broken government programs weighing on the country. And our much vaunted democracy is increasingly dysfunctional— rotten to the core, truth be known— thanks largely to entrenched special interests and a voting public clamoring for their own piece of the pie [[bread and circuses!?!: normxxx]], while trying to hand the bill off to somebody else.

Meanwhile, the economy— despite rigorous jawboning by the government and its many friends in the large banking institutions— is in serious trouble [[which is desperately getting worse: normxxx]], with the housing market buffeted by tsunami-like waves of defaults, foreclosures, overvaluations, historic levels of personal debt, and tight credit that has left the U.S. government as the sole lender in many if not most major markets. Bernanke and his ilk may see 'green shoots', but what they're most likely seeing is Kudzu springing up once again to bury the economy.

That's The Bad News

The potentially good news, if you credit Howe's research, is that the Crisis we're now entering will change pretty much everything. While this change will entail a great deal of pain and a reduced standard of living for a large number of people, by the time the Crisis subsides, society will have pretty much remade itself in ways that no one can predict at this point. [[but, given past experience, likely to be a whole lot better.: normxxx]] Put another way, today's intractable problems will be solved… one way or another.

What's Next

When discussing what's likely to follow next, Neil Howe turns to his generational profiles and points out that the rising societal power today belongs to the generation he calls the Millennials, individuals born between 1982 and 2004. They are a "Hero" generation, just like the G.I. Generation that coped so well with the turmoil of the Great Depression and World War II— the last Fourth Turning. Coddled as children, the G.I.s were ultimately called upon to help society through a dark and dangerous period and rose to the occasion. Again, quoting Howe on the Millennials…

"These are today's young people, who are just beginning to be well known to most Americans. They fill K-12 schools, colleges, graduate schools, and [whose leading edge has just] recently begun entering the workplace. We associate them with dramatic improvements in youth behaviors, which are often underreported by the media. "Since Millennials have come along, we've seen huge declines in violent crime, teen pregnancy, and the most damaging forms of drug abuse, as well as higher rates of community service and volunteering. This is a generation that reminds us in many respects of the young G.I.s nearly a century ago, back when they were the first boy scouts and girl scouts between 1910 and 1920."

Unlike the Baby Boomers, who are largely 'individualistic' and 'anti-establishment', the Millennials are good team players. We hear a lot these days about working together for a common cause, volunteerism, and the need for stronger government institutions, largely because these are the new priorities of the Millennial Generation. As you may recall, out of the devastation of World War II, a spate of transnational political and economic institutions were born, including the United Nations, the World Bank, the World Health Organization, and the International Monetary Fund. By the time the current Fourth Turning is over, expect more of the same— but probably even bigger and more ambitious.

What Does This Mean to You?

Most importantly, if Howe is right, this crisis is far from over. In fact, when I asked him where we are today on a scale from 1 to 10— with 10 representing as bad as the crisis will get— he replied that we are at either 2 or 3. In other words, the worst is very much yet to come. And, per above, he expects this period of turmoil to take 20 years to play out. Thus, if nothing else, you may want to continue approaching matters of personal finance cautiously.

Secondly, if you're the type of individual that tends to get steamed up by larger and more intrusive government programs, you may want to take a few deep breaths and resolve yourself to the fact that this phenomenon is likely to get far worse before we see a return to a celebration of 'individual' rights. (And the cycle shows that we will see such a return— about 40 to 50 years from now, when the next Second Turning comes around.)

If it is any consolation, the Millennial Generation places a great deal of weight on teamwork and the notion of doing things "smartly". That doesn't mean, of course, that the various programs that are kicked off in an attempt to fix the many problems now confronting society will necessarily turn out to be 'technically' smart. But they will almost certainly be better thought out than some of the numbskull initiatives we've seen over the last 20 years.

You can also take some comfort in the fact that Millennials are builders, not destroyers. By contrast, the individualistic Boomers that dominate today's aging political class are world-class dissenters, radio talk show 'aficionados' always ready to scrap it out for their beliefs. Millennials want to skip the philosophical debate and get straight to fixing things.

Other insights about Fourth Turning periods gained from my conversation with Neil Howe…

• Government grows powerful, and sweeping new legislation is enacted. The old 1990s rule was: just compete and stay off the state's radar screen. The new 2010s rule will be: better have a presence in Washington so you're not dealt out of the "new" new deal. One political party tends to dominate. The Democrats under FDR during the last Fourth Turning offer a good example. While Neil Howe doesn't think it will necessarily be the Democrats this time around, they are certainly in the pole position at this point.


• While public history speeds up, personal life slows down. Families will spend more time together, as in the old Frank Capra movies. Ever more households will be multi-generational, a trend now spurred by Boomers with large, empty McMansions and Millennials without jobs. There will be a blanding of the pop culture, with the entertainment of the young (put Miley Cyrus or "High School Musical" on fast forward) increasingly regarded as tamer than the entertainment of the old.


• Innovation tends to stagnate, while a few new technologies will be chosen to be adopted on a large scale. We will see the equivalent of canals or railroads or interstates being built across America. To borrow from Carlotta Perez' four-stage description of technological revolutions, we are moving from the "innovation" to the "implementation" stage.


• New laws and regulations will do less to referee a 'free' market and more to pursue one or another national priority. They will increasingly favor the large producer over the retail buyer, investment over consumption, planning over risk, debt over equity. Businesses will hustle to reposition themselves. Anti-trust legislation will weaken.


• The authority and obligations of community will strengthen at all levels, from local to national and possibly beyond (if our alliances prove durable). Personal reputation and membership will matter more. A "new localism" will reshape town and urban planning. A global slide toward national or regional protectionism will loom as a real danger.


• It is too early to tell whether the crisis will ultimately be inflationary or deflationary, though we at Casey Research come down on the side of inflation for the simple reason that the government possesses the means to inflate. Due to the gold standard, that was not the case early in the Great Depression.


• In the past, Fourth Turning periods have always resulted in the nation redefining who we are in some essential way. That was certainly the case during the American Revolution, when we transitioned from a British colony into a collection of independent states— and the Civil War, when those states were hammered into a single nation. And, again, after World War II, when the U.S. went from being a relatively isolated nation to a global empire. A wild card, for instance a terrorist nuke going off in a city anywhere on the planet, could similarly take the country, and the world, into unforeseeable new directions.


• Baby Boomers will continue to be respected for their cultural achievements (it's not a fluke of history that Boomer music and other entertainments are still wildly popular among the young), but will be increasingly ignored in the political debate. The term "senior citizen," already in decline, will disappear entirely. And if push comes to shove, Boomer's financial interests— including Social Security— will be subjugated "for the greater good."


• There will be a growing push to rebuild the middle class. The wealthy and the impoverished alike will both come under pressure thanks to new pro-middle class initiatives. If you are a high-income earner, it's a certainty your taxes are going up, and likely by a lot. If you want to make a fortune, don't pursue the niche or the "long tail". Invent the next big brand that will appeal to Everyman.

Don't Worry, Be Happy

That is, at best, a sketch of my long conversation with Neil Howe and doesn't do justice to his research. If nothing else, however, I hope I've succeeded in giving you at least some sense of the man and his unique research and encouraged you to think outside the box about the nature of today's crisis.

A couple of final observations.

First, Neil Howe is not a 'negative' person, nor a professional doomsayer. Rather, he is a social scientist and historian with decades of experience in the social sciences. As you speak to him, you get the sense that he doesn't view the world through any particular philosophical bias, but rather is simply reporting what his research is telling him about the current players on the global stage, and which act we are currently in. Second, speaking for myself (David) as a Baby Boomer and someone with a lifelong distrust of government and its meddling institutions, talking to Neil left me feeling oddly relaxed— letting go, if you will, of some of the frustration that has been building within me as I watch the 'nanny state' grow more and more bloated.

That is not to say that we at Doug Casey won't continue to speak out against government waste and profligacy. We will. But it seems increasingly clear that we're now caught up in a powerful trend toward bigger, not smaller, societal institutions— and that these institutions will, over the period ahead, change the world as we know it. Of course, being active investors, at the same time we raise our voices in protest, we'll deal with the reality of the situation by strategically positioning our portfolios to profit from the coming changes.

And so, like the Rockefellers and J.P. Morgan during the Great Depression, we'll 'make the trend'— no matter how negative— 'our friend'. You may want to consider doing so yourself.


See also:

Generation Gab (7/8/2008)

The Next New Deal

13th Gen: Abort, Retry, Ignore, Fail? Remember, Obama is a Gen-Xer!

CSIS— Global Aging Initiative:

"As recently as 1980, the median age of the oldest society on earth (Sweden) was 36. By the year 2030, the median age of the entire developed world is projected to be 45. In Japan and much of southern and eastern Europe, it will be over 50. As a whole, the developing world will remain much younger for the foreseeable future. Yet it too is aging"

The 2003 Aging Vulnerability Index; The Graying of the Middle Kingdom (2004); The Aging of Korea: Demographics and Retirement Policy in the Land of the Morning Calm.