December 2, 2022

Archives for December 2008

Is Burying Your Cash The Answer?

Fear and loss of confidence in our economic future due to over leverage can be seen in many areas.  There have been many stories lately about individuals attempting to secure their future by burying cash in their backyards.  Those of presumably greater means with the same idea have propelled safe manufacturers into one of the few industries showing sales growth today.

Burying cash is an old idea born of the depression years prior to the FDIC when if a bank went under you lost your money.   Under the current Federal guarantee of bank deposits, the failure of a depositor to be made whole would be equivalent to a default by the Federal Treasury.

Those inclined to burying cash should ponder the baseball card craze of years past.   Baseball card “investors” would fill their garages and basements with boxes of unopened cards and dream of the day when their value would skyrocket.  The card sellers made money but the buyers failed to realize that the cards they were buying as collectibles were being produced in massive quantities, almost guaranteeing little scarcity value in the future.  Paper cards could also be flawlessly produced in quantity by counterfeit card operators.  While individually graded cards merited an investment consideration, holding boxful’s of ordinary cards did not seem wise.

The cash dollars of today are the baseball cards of yesterday.   Dollars can be produced cheaply and in infinite quantities as deemed necessary by the Federal Reserve.  There is a risk of buried cash being lost or stolen.  There is no risk betting that the Government will print as many dollars as necessary should the downward economic spiral continue.  As the Government assumes the massive losses of every more entities via bailouts, those still holding the cards may become the winners (from a value standpoint) over those holding dollars.

My viewpoint is that one asset class deemed worthy of investing in to preserve wealth is gold, as discussed in Gold, Cheap at $5,000?

Gold investors have been laughed at for years and there have been long periods of declines and/or under performance in price versus other asset classes.  Gold, however, is the only monetary asset where the ultimate value of your investment is not subject to someone’s else’s promise or ability to pay.  I view gold as the ultimate insurance hedge against a government’s propensity to spend itself into insolvency and, accordingly, I believe that gold should constitute 10 to 20% of one’s core investment assets.   Historically, governments  have regularly and repeatedly defaulted on their sovereign debts.  In every such case of default, the citizens of those nations would have been far better off holding gold rather than government paper.

Rampant Corruption Symbol Of Empire’s Decline

Illinois Governor A National Disgrace

The latest example of horrendous corruption in government was the arrest of Illinois Gov. Rod Blagojevich.   Among the many charges brought against him by Federal prosecutors was that the Governor was attempting to sell a senate vacancy to the highest bidder.   Given the level of corruption we have witnessed in this country lately, I think it would be more appropriate for a vacant seat to be filled by an election rather than appointment.  The temptation by politicians to profit from their positions of power is obviously too great a temptation for many of them.

This latest brazen example of an elected public official betraying the power of his office and the trust of his employers (the voters) is all too common.  Even when captured with indisputable video and audio proof of their crimes, these criminal politicians have the audacity to deny their guilt and then attempt to continue in office as if nothing had happened.  The Illinois Governor is symptomatic of a society that has lost its moral compass.  Respect for the law is what makes a society civil.  When our highest elected officials commit criminal acts as a matter of routine it sets an example too easily followed by others.

Not Just An Isolated Example – Connecticut Governor Rowland Sent To Jail

Former Gov. John G. Rowland was sentenced to a year in prison and four months of house arrest Friday for selling his office in a corruption scandal.

Rowland, 47, pleaded guilty in December to a corruption charge, admitting that he sold his office for more than $100,000 in chartered trips to Las Vegas, vacations in Vermont and Florida, and improvements at his lakeside cottage. He resigned last summer amid a gathering drive to impeach him.

Through it all, Rowland maintained that he never did anything wrong and predicted the corruption investigation would never touch him.Rowland will become one of more than a dozen former governors to serve prison time and only the second in New England. The first was former Rhode Island Gov. Edward D. DiPrete, who was sentenced to a year in prison in 1998 for bribery, extortion and racketeering.

Rowland will become one of more than a dozen former governors to serve prison time and only the second in New England. The first was former Rhode Island Gov. Edward D. DiPrete, who was sentenced to a year in prison in 1998 for bribery, extortion and racketeering.

The real injustice here is that the Governor was subsequently let out of jail after serving only 10 months and then proceeded to get a high paying job with no difficulty.  Those without political connections have served far more time for far less crimes.  Obtaining a high paying job straight out of prison would seem to indicate that the Governor can still command a high price for his connections and past favors to various interest groups.

New York Governor Elliot Spitzer Resigns After Prostitution Charges

The former crime fighting district attorney, ex Governor later had the charges dropped.  Apparently the Governor still has friends in the law enforcement community.

Alaska Senator Ted Stevens Guilty On 7 Felony Counts- Senator Maintains His Innocence

Sen. Ted Stevens of Alaska, one of Congress’s most powerful Republicans, was convicted yesterday of lying on financial disclosure forms to conceal his receipt of gifts and expensive renovations to his house, just eight days before he faces voters in a tight reelection contest.

The 84-year-old lawmaker, the first sitting U.S. senator to go on trial in more than two decades, sat quietly as a jury foreman in federal court read the verdict after less than a day of deliberations: guilty on seven felony counts, each with a maximum penalty of five years in prison. The senator, who probably will face a less severe penalty under federal sentencing guidelines, left the courtroom without answering reporters’ questions.

In a statement issued by his office, Stevens maintained his innocence, accused Justice Department lawyers of “repeated instances of prosecutorial misconduct” and vowed to fight for reelection to a seventh full term.

This country’s pattern of civil and fiscal decline echoes the warnings issued by David Walker, of the Peterson Foundation, an organization that has been trying to educate America about the fiscal emergency we face due to reckless borrowing.

Walker compares our nation’s fiscal morass to the one that helped topple the Roman Empire. In one speech he argued, “Rome fell for at least four reasons, and please listen carefully: A decline in moral values and political civility at home, an overconfident and overextended military, fiscal irresponsibility by the central government and inability to control one’s borders. Does that sound familiar?”

Is this democracy at its worst with a betrayal by our elected leaders, or is it a failure equally shared by both the voters and its elected leaders?

Items Of Interest

Life Insurers Seek TARP Funds But Pay Little In Tax

Several of the biggest U.S. life-insurance companies are seeking a piece of the taxpayer-funded $700 billion federal bailout program, but pay little in income taxes themselves, securities filings show.

Consider Prudential Financial Inc., which last week announced that it is seeking an unspecified amount of aid through the federal Troubled Asset Relief Program, or TARP.

Despite reporting pretax profits to shareholders of nearly $25 billion over the past decade, Prudential has paid just $1.3 billion in taxes to federal, state and foreign governments in that period, filings show, for an effective tax rate of 5.1%. That compares with a statutory combined federal and state corporate income-tax rate of about 39.5%.

When you can pay good lobbyists, good things happen.  If they paid higher taxes, our life and car insurance premiums would cost more; can’t really get upset about this.  You can be certain that with the recent large losses the insurance companies have taken (plus probably more to come) that they won’t be paying taxes for some time due to tax loss carry forward credits.

Executive Accused in Mortgage Scheme

A financial executive used little more than a pen to alter credit scores and reclassify mobile homes as single-family houses, inflating the value of thousands of mortgages that were repackaged and sold to investors, prosecutors allege.

Mr. Gordon, a former director of residential acquisitions at Bayview, made more than $2.8 million in additional commissions by altering the value of 2,800 loans from 2001 to 2006, according to documents filed by prosecutors in U.S. District Court in Miami.

The worst part of this mortgage fraud was the ease with which it was carried out.  This is just the tip of the iceberg.  At the peak frenzy of the mortgage bubble, there were few controls or oversight, underwriting standards were a joke and everyone was too busy cashing their paychecks to notice anything.

Madoff Charged in $50 Billion Fraud at Advisory Firm

Bernard Madoff, founder and president of a New York firm that invested funds for wealthy individuals, hedge funds and other institutions, was charged with operating what he told employees was a long-running $50 billion Ponzi scheme in what may be one of the largest frauds in history.

This is truly off the scale.  Would this fraud have continued if not for the huge drop in stocks and other asset values?  Look for continued financial horror stories as the economy weakens.  Wall Street brokers are going to have a very tough time soliciting new customers.

Household Net Worth in U.S. Declines Most on Record

U.S. household wealth fell in the third quarter by the most on record as property values and stock prices tumbled, highlighting the tattered state of consumer finances even before the most recent slump in lending.

Net worth for households and non-profit groups decreased by $2.81 trillion, the most since records began in 1952, according to the Federal Reserve’s Flow of Funds report issued today in Washington. Real-estate-related assets declined by $646.9 billion, three times the prior quarter’s drop.

All of the wealth accumulated since the third quarter of 2006 has been vaporized and this does not include the horrific market sell offs that occurred in October and November which probably wiped out another $4 trillion in wealth.  Not surprising that investors are putting what is left into “risk less” treasury paper paying zero per cent.

Is America On A Downward Slope?

America has given indications that it has reached its peak and is on a downward slope. The U.S. government has taken measures in the last 11 months that appear to be a desperate attempt to keep our dysfunctional corrupt financial system propped up.

Exceptionally well written and thought provoking masterpiece, well worth the read.  You may not feel very bullish after reading this.

Fannie & Freddie May Waive Appraisals On Refinance

Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government, are considering forgoing new appraisals on refinanced loans to help struggling homeowners, their regulator said.

This action, if taken, is equivalent to lending at a loan to value of over 100%.  Looks like another desperate attempt to prop up the property markets which won’t succeed.  If the government could have controlled housing prices, they never would have declined in the first place.  What investor in his right mind will buy mortgage paper going forward?  Without government guarantees, mortgage rates would be somewhere between the yield on high grade corporates and junk bonds.

Long Term Housing Stability Based On Strong Borrowers

When will the housing market improve?  That seems to be the question of the day so I offer some observations.

When you hear that financing is hard to get for a home mortgage, what you are really hearing is that unqualified buyers are not being approved.

If you can verify adequate income, are able to make a down payment of at least 3% and have decent credit (at least a 580 FICO score), getting a mortgage approval at a low rate is not difficult.  You will not be approved for a mortgage if you cannot verify your income, if you have terrible credit or if your income is insufficient to support your mortgage and other debt payments.  This is a healthy change for housing long term since ultimately, weak buyers are not capable of sustained home ownership.

Buyer psychology is an important part of the home buying process.  Just as in the stock market,  where higher price trends will entice more buyers, the same is true of housing.   Everyone talks about the wisdom of buying when prices are down, but the fear of future price depreciation deters present buying; everyone wants to wait until they can see a bottom.

Most responsible borrowers need to feel financially secure before purchasing a home.   With a very weak economy, job losses and lack of confidence in the future, most prudent people will think twice before taking on the large financial commitment of owning a home.  The disappearance of 100% financing also means that a buyer faces the loss of his capital investment if the mortgage payments cannot be maintained.

Is it cheaper to rent equivalent housing?  If it is cheaper to rent, does that imply that housing is overpriced?   Have prices been adequately discounted to adjust for past purchases made with easy financing by speculators and unqualified buyers?

A buyer contemplating a home purchase today must consider whether the various government schemes to keep delinquent homeowners in their homes is artificially propping up the market and extending the decline of housing prices.  If a homeowner is unable to pay his mortgage today and with incomes and jobs disappearing, how likely is it that a delinquent homeowner’s income will increase?  Are the loan modification programs and foreclosure holidays making a home buying decision more difficult?  If these programs fail, will the future flood of foreclosed homes on the market cause further large home price decreases?

Is the average buyer today prepared to pay the large maintenance and repairs associated with home ownership?  If buyers today see little chance of future price appreciation, are they prepared to invest a large part of their free time maintaining a home?

Given the large transaction costs of buying or selling a home is it worth purchasing a home unless you know with certainty that you will remain in the home for an extended period of time?  Transaction costs including sales commissions, financing and moving can easily equal 10% of an average home’s value.

Am I really ready to own a home?  In the past, when people foolishly believed that housing values could only go up, this question was rarely asked.  Before considering the purchase of a home, a buyer should discuss in depth with other homeowners the pros and cons of home ownership.  The question of whether to buy or rent has never been more difficult.  A very uncertain housing future and lack of confidence breeds indecision and purchase deferral.

Many of the current problems in the housing market arose due to the easy credit offered to buyers who should have stayed renters.  Buyers should not consider the purchase of a home unless their total mortgage and other debt payments are easily affordable.  Buyers should not use their last dollar of savings when purchasing a home.  Many unexpected expenses will routinely come up.  If you don’t have at least 6 months of income in savings, after your down payment, consider postponing the purchase until your finances improve.   After years of  house buying mania and then a bust, how many confident and strong buyers are out there?

Most mortgage companies and home builders involved with first time home buyers offer advice on determining the affordability of a buyers mortgage payment but do not address many of the other issues discussed here.  Major companies such as KB Homes, for example, discuss the affordability question, but I think more needs to be done in this area.

In the long run an educated buyer with financial stability will be the bedrock of a stable housing market.   Hopefully, future regulations arising from the current housing crisis will address the issue of educating home buyers and make this a mandatory part of the home purchase process.

A World Of Zero Interest Rates

We have arrived at 0 interest rates and the reasons we are at this point are all negative indicators for where we are and where we are heading.

Theodore Ake, head of U.S. Treasury trading at Mizuho Securities USA Inc. in New York, one of the 17 primary dealers of U.S. government debt, said some investors bought three-month Treasury bills from his firm with negative yields of 0.01% to 0.02% Tuesday. By the end of active trade, the yield had inched back up to positive 0.02%.

In round numbers, the investors were willing to pay $100, knowing they would get $99.99 in return, in the belief that a small but guaranteed loss was preferable to investing in stocks, corporate bonds or other securities. Treasurys have been flirting with 0% yields since the Lehman Brothers bankruptcy nearly three months ago.

“The bond market is doing a much better job than stocks right now of telling you about the risks that are out there,” said Thomas H. Attenberry, a partner at First Pacific Advisors, an investment-management firm in Los Angeles. The high yield investors are demanding on anything other than Treasurys is particularly worrisome because companies need to refinance more than $800 billion worth of debt next year, according to analyst estimates.

The notes the extraordinary amount of risk aversion taking place as investors loss their confidence in the ability of anyone other than a central bank to repay their debts.

The investor search for a safe places to store wealth as the financial crisis shakes faith in the system has caused extraordinary moves in global markets over recent days, driving the yield on 3-month US Treasuries below zero and causing a rush for physical holdings of gold.

“It is sheer unmitigated fear: even institutions are looking for mattresses to put their money until the end of the year,” said Marc Ostwald, a bond expert at Insinger de Beaufort.

The rush for the safety of US Treasury debt is playing havoc with America’s $7 trillion “repo” market used to manage liquidity. Fund managers are hoovering up any safe asset they can find because they do not know what the world will look like in January when normal business picks up again. Three-month bills fell to minus 0.01pc on Tuesday, implying that funds are paying the US government for protection.

“You know the US Treasury will give you your money back, but your bank might not be there,” said Paul Ashworth, US economist for Capital Economics.

The gold markets have also been in turmoil. Traders say it has become extremely hard to buy the physical metal in the form of bars or coins. The market has moved into “backwardation” for the first time, meaning that futures contracts are now priced more cheaply than actual bullion prices.

The latest data from the World Gold Council shows that demand for coins, bars, and exchange traded funds (ETFs) doubled in the third quarter to 382 tonnes compared to a year earlier. This matches the entire set of gold auctions by the Bank of England between 1999 and 2002.

Credit markets may have thawed somewhat but after suffering horrendous losses on virtually every asset class, investors seem determined to put whatever cash they have left in the most risk free category possible – even if that means paying for the privilege via negative interest rates.

A desire for a return of capital rather than a return on capital, as the old saying goes, is what we are looking at here.  Of course, at some point, the disgust of receiving a zero return on your money is bound to drive at least a portion of the capital now in treasuries into another asset class.  Investors will be willing to risk some of their capital in another asset class which might be riskier but which also promises some good chance of obtaining a return on capital.

My guess is that one such asset class will be gold, as I previously discussed in  Gold, Cheap at $5000?
I view gold as the ultimate insurance hedge against a government’s propensity to spend itself into insolvency and, accordingly, I believe that gold should constitute 10 to 20% of one’s core investment assets.   Historically, governments  have regularly and repeatedly defaulted on their sovereign debts.  In every such case of default, the citizens of those nations would have been far better off holding gold rather than government paper.

Similar Chart? Similar Ending?

Every bubble in history required easy credit, for without that credit buyers could not buy.  As prices rise, more buyers enter, fueled on by easy credit and increasing prices – a positive feedback loop.

What happens when the credit stops?

Dow Jones

This chart is reminiscent of other markets that no one ever thought would drop:

Nikkei 1990

Dot Com 2000

Oil 2008

What The Fed Is Up Against

A chart is worth a thousand written words.

As we behold this chart of debt growth in the US, we need to ask ourselves:

  • Has any trend similar to this in history ever been able to continue indefinitely?
  • This debt is backed to a large degree by asset collateral – will the ongoing destruction of virtually every asset class be the tipping point?
  • To prevent a totally horrific destruction of asset values, does this growth trend in debt need to continue?  The actions of the Fed would imply that a slowdown or reversal of credit growth would be catastrophic to the world economies.
  • Paper money is based on confidence which is becoming thinner by the hour.
  • This chart is probably in the back of the minds of those choosing to receive negative interest rates from the Government on short term paper to avoid credit losses.
  • When debts are so large that they cannot be paid back by the borrowers, then by definition they will not be paid back.

California Ignores Growing Fiscal Crisis

California’s budget crisis is growing worse as its shortfall for its current fiscal year has increased to an estimated $14.8 billion from a previously estimated $11.2 billion, Gov. Arnold Schwarzenegger said on Wednesday.

During a press conference broadcast on his office’s website, the Republican governor said he would call top lawmakers into a meeting to stress the need for fast action by the Democrat-led legislature on balancing the budget of the government of the most populous U.S. state because it may be out of cash by the end of February.

General fund revenues for November were down a staggering 18% from already reduced expectations.  The Governor had previously demanded action from the legislature to address the fiscal situation but was stymied by competing political agendas.  The Republicans don’t want to raise taxes and the Democrats don’t want to cut spending.   As California’s debt ratings continue to sink and investors boycott their debt offerings, it has become obvious that the previous solution of borrowing to cover out of control spending will not work this time.

California’s budget has increased by an astonishing 40% over the past four years.  Gov. Arnold Schwarzenegger was voted into office on a promise to cut spending and establish some semblance of fiscal sanity.  He soon gave this effort up when his popularity ratings plummeted as he attempted to rein in out of control spending. Every spending cut is essentially a reduction of benefits or cash payments to various voters.   The voters are apparently accustomed to ever increasing benefits and payments, without the nuisance of having to pay for them.  Pandering politicians have attempted to give everything to everyone at no cost and accordingly created a sense of entitlement by the voters.   Demands for new benefits will only grow larger with unemployment at almost 10% and surging higher by the day.

We are now seeing the end result of fiscal insanity – an over leveraged state that has reached the limits of borrowing, politicians who will not confront reality, voters who will not tolerate tax increases or spending cuts and the largest State economy on the verge of fiscal collapse.   This has been discussed as a national issue previously –   IOU’S Pile Up – Taxpayers Refuse to Pay.

The only action California has taken to date, which does not address the reality of their situation has been to offer IOU’s to the State’s vendors and suppliers.  Those who chose to accept these IOU’s will soon find themselves as bankrupt as the issuer.

This fiscal lunacy will continue until California has borrowed and spent its last dollar.  When this point is reached the next phase of Federal bailouts will commence with 49 other states lined up behind California.

Ultimately, serious minds will begin to question the financial integrity of the United States.

Bank of America Receives Day’s Hall of Shame Award

BofA to Offer Loans to Illinois Factory

Bank of America  Corp. said it will provide a “limited amount” of additional loans to an Illinois door-and-window factory, just a day after sit-in protests escalated into an intense labor-relations fight that threatened to have financial ramifications for the banking giant.

Last week, the factory notified its nearly 300 employees, of which about 80% are unionized, that it would close by Friday because Bank of America had told the company it would be cutting off all financing.

President-elect Barack Obama offered support for the employees, saying at a news conference that they are “absolutely right.”

A factory in Chicago declares bankruptcy and the employees stage a sit in for back wages that were allegedly unpaid.  The company was forced to close after Bank of America refused to extend further credit to a bankrupt enterprise.   State and local politicians roundly condemn Bank of America and the president elect states that the workers were “absolutely correct”.

Result – Bank of America extends more credit to a bankrupt enterprise.

It’s bad enough that the politicians are using taxpayer money to bailout enterprises that perhaps do not deserve anything better than bankruptcy court.  Is this the new simpler method of bailout mania – forcing the insolvent banking system to further fund bankrupt companies?  Does this remind anyone of central government planning, the same methods that the former USSR employed?

The precedent set here will only lead to further destruction of capital.  If the politicians want to become lenders, let them start their own banks with their own capital; they can be certain that they will have many customers and many write downs.

Bank of American should have resisted the political pressure and maintained what little they have left of underwriting standards.


How do you say no to the next 1,000 companies that close their doors?

Was this factory the “victim” of a poor economy and Bank of America, or where they just another poorly managed, overleveraged enterprise?

Could the money lent to this bankrupt company have been better employed elsewhere?

Will the government’s vastly increased control over the banking industry (due to bailout funds and equity ownership) result in capital allocation being based on political pressure rather than sound business judgment?