Archive for November, 2011

That Hole in Your Foot

Wednesday, November 30th, 2011

So, dude, what’s up with that hole in your foot?  Before removing your shoes, please understand this question is not directed to you, dear reader, but to the European Banking Authority (EBA).  These are the folks who must stress out individual banks in Europe as they probe for areas of weakness.  Some would argue that additional stress is the last thing these institutions need but that is moot.  The EBA is there to test for solvency, the ability for individual members of Europe’s financial network to remain standing should something really bad happen.  Good thing, I say.  Don’t look now but some really bad things seem to be happening there right now.

According to The Economic Times of India, the EBA has directed lenders in Europe to increase their reserves substantially as protection against losses from bonds issued by nations rimming the southern edge of that continent.  The intent was to have banks put more cash aside for a rainy day.  The response however, has differed.  In their quarterlies, many of the largest lenders report they have begun dumping their holdings of such sovereign debt onto the market, often at a substantial loss.  The end result of the EBA’s mandate had been to remove one of the major buyers of sovereign debt at a time no alternative is available to fill the vacuum created.

The EBA is fairly new at this business, having been created just in January of this year.  Still, I imagine the European Parliament’s hope was to generate stability.  Instead they seem to have shot themselves in the foot first time out.  How surprising is that really?  A committee of greenhorns can generally be snookered by a pack of pros who have cut their teeth on previous crises and know quite well how to play the game of high finance.

Throwing BRICs at PIIGS

Tuesday, November 29th, 2011

Do not be alarmed by the title.  I do not mean to advocate any form of animal cruelty.  Please don’t report me to PETA.  I mean no harm.  Don’t inform the SPCA; they have better things to do with their time.  The world is full of acronyms and I am merely employing two which have been bandied about over the past couple of years or so to make a point.  Allow me to explain.

PIIGS is an abbreviation for Portugal, Ireland, Italy, Greece and Spain.  They have been singled out as a representative group of European countries abetting the economic ruckus centered within the European Economic Community, although they are by no means the only weak links in that chain.  Many economists feel the entire continent may be on the verge of a recession which could spread across the world.

Enter the BRICs: Brazil, Russia, India and China.  These four countries are seen as representing the power of emerging markets.  The combination of their population’s size and age combine with an improving living standard to provide the (old) developed world with vigorous consumers able to thwart this specter of recession and carry the planet into a brighter, more prosperous future.  In theory.

Here’s another theory for you.  Publically traded companies listed on exchanges within their respective countries can be combined into an index which reflects to some degree the health of each nation’s economy.  For instance, while no one can actually buy an index per se, we can look to the Dow Jones Industrials to get a feel for the general economic health of the U.S.  When applying this reasoning to Europe we should not be surprised to see the Athens exchange or Borsa Itaniana hovering at their lows for the year.  What may surprise you is a quick look at the Bovespa of Brazil, Russia’s MICEX, India’s SENSEX or China’s Hang Seng.  What are they doing so close to their annual lows as well?

The names have changed over the decades but old saying, often repeated, goes “When country A sneezes, Country B catches a cold.”  This new global economy is complicating such attribution.  Instead, it is coming to resemble a kindergarten where every cough and sniffle gets passed around, infecting everyone.

Third Quarter Productivity

Monday, November 28th, 2011

Productivity increased in the third quarter according to the Bureau of Labor Statics’ preliminary tally.  In short, America produced an annualized 3.1 percent more an hour than in the second quarter of 2011.  The output managed to grow by 3.8 percent while it only took 0.6 percent more hours worked to produce the additional output.  From the third quarter of 2010 to the third quarter of 2011, output increased by 2.5 percent and hours worked ticked up 1.4 percent resulting in a 1.1 percent increase in productivity.  Gains in productivity are significant for a country that wants to export more since productivity growth helps keep prices competitive on the global market.  These gains also assist price stability in the US.

The advantages gained from productivity can be lost if wages grow too fast.  Unit Labor Costs measures the relationship between hourly compensation and the increase in productivity.  Third quarter wages rose only 0.6 percent which is less than the 3.1 percent gain in productivity; in general, this means the labor portion of an item’s cost fell and helped keep prices from rising.  Since labor is the largest cost to producers, sustained pressure from wages will eventually impact prices.   Over the last four quarters, hourly wages grew faster than productivity, so the latest quarter’s data is a pleasant development from an inflation perspective.  (by Christopher Cox)

Planning with Jerry

Friday, November 25th, 2011

I may have told you previously about a friend I had long ago named Jerry who was serious about his partying.  On occasion he would arrange to have me meet him at a bar partly for camaraderie and no doubt also because he expected someone besides himself would need to drive.  He was always the man with a plan.  He would tell me, “If I get there first, I’ll draw an X with chalk on the sidewalk outside the bar.  If you get there first, rub it out.”

European leaders are doing everything they can not to trigger the default clauses in those pesky Credit Default Swap (CDS) contracts connected with sovereign debt that seem ubiquitous.  They are, instead, trying to persuade banks and other bondholders to accept a 50% loss on their Greek debt holdings by swapping into new bonds at a substantial discount (see the NYT Nov 19 article Scare Tactics in Greece for an update).  Some within the European Union (EU) and the European Central Bank (ECB) are desperately trying to call this a voluntary exchange, thereby apparently allowing the official arbiter of such matters, the International Swaps & Derivatives Association (ISDA), to avoid calling the result a default. You see, calling such a default an actual default would trigger the obligatory payments required by the insurance CDS contracts represent.  Issued primarily by the largest banks both here and in Europe, this could potentially translate to enormous losses at these institutions.

This may not sound all that above board to you.  It certainly doesn’t to us here at Atlas, especially when you consider that the ISDA ruling calling for these actions to be deemed voluntary, now apparently baked into the cake by an even earlier EU compromise, favors the big banks that sold these CDSs and also conveniently sit on the ISDA board.  This may make about as much sense as my buddy Jerry did.  Smaller banks and other bondholders who don’t have such influence might challenge the ruling in court.  The consequences of such action may argue to fairness but the results are undeterminable.  Even they may fear the unknown in this instance.  Here at Atlas, we are holding our breath as these issues work themselves out, aware that some of the biggest banks there are also some of the biggest players here.  In this interwoven pastiche called global banking, European banking problems could detrimentally influence a wide range of financial matters here, including both mortgage and housing markets.

Musical Snares

Wednesday, November 23rd, 2011

Here in the US, according to the Office of the Comptroller of the Currency, five of our largest banks (JPMorgan, Morgan Stanley, Goldman Sachs, Bank of America, and Citibank) write 97% of all insurance protecting investors against defaults on bonds.  Called Credit Default Swaps (CDS), they are a promise by the banks to make lenders whole if the issuer of a bond can’t repay the borrowed funds.  Amongst others, these policies cover debt issued by Greece, Italy, and Spain.  In recent disclosures, JPMorgan and Goldman Sachs alone said they have sold protection covering over $5 trillion of debt world-wide.  That sounds like a lot of money to me, but does it sound like a good idea?

The banks report they have established master netting agreements which theoretically transfer some or all of the risk to someone else.  In other words, they bought insurance to protect themselves against the insurance they sold.  They aren’t telling who those policies were purchased from, asking us instead to just trust them, so we are left to guess.  With about 74% of CDS trading taking place among 20 dealer-banks worldwide per data from the Depository Trust & Clearing Corp., we can whittle the list down substantially.  It seems to me the risk gets elevated proportionately as well.  If just two banks wrote over $5 trillion of these CDSs, what must the global total be?  And this same handful is buying protection from each other?  Geez, that’s what led to the collapse of Lehman, and that was on a much smaller scale!  Do you think somebody ought to say something?

If any one were to step forward and begin asking for a touch more disclosure, I would expect the inquiry to be led either by our Treasury Department or maybe the Federal Reserve.  Since both Secretary Geithner and Fed head Bernanke have recently gone on record saying they aren’t worried about U.S. bank exposure to European sovereign debt, maybe I should just go back to sleep.  But I’m still having restless nights.  Could a single default by any nation involved create a chain reaction of claims which couldn’t be met in a timely fashion, causing the global monetary network to seize up?  That’s what happened with Lehman and AIG.

This all reminds me of that game Musical Chairs I played as a kid where everyone paraded to music around a circle of chairs arranged facing outward.  When the music stopped, all the players tried to grab a seat.  The problem was there was always one more player than there were chairs, so every round another person was eliminated until just two players fought for the last seat.  That’s where the similarity ends.  No one seems to question that these institutions are too big to fail; they will still get the last chair.  Just like the last time, I suspect money will be created to keep them solvent.  This means that the last man standing will somehow be you.  Whether the end result proves inflationary or leads us instead into a deeper recession, we the people will ultimately get the bill if such a collapse occurs.

Stir Up a Roux

Tuesday, November 22nd, 2011

Allow me to share one of my favorite recipes.  Get yourself a bunch of hard-boiled eggs.  This is great after the Easter egg hunt but I make it up all year around.  Remove the yolks and cut the whites into little bites.  Mash the yolks in a separate bowl with a fork.  Now you make a white sauce, starting with the roux.  Toss a dollop of drippin’s or butter into a hot skillet along with an equal amount of flour.  Stir it all around with vigor until things turn golden and just a bit thick.  Turn down the heat some and add a couple of cups of milk.  Stir it constantly until the sauce begins to thicken up a touch.  Add the egg whites.  Put slices of hot buttered toast on a plate, slather the white sauce on top, then sprinkle the yolk over that and enjoy yourself.  I’ll promise you right now, it’s larrupin’.  My family always called it eggs a la goldenrod.

The trickiest part is getting the white sauce just right.  After adding the milk, it takes a while for the roux to thicken everything, and you have to keep stirring up the whole mess.  However, if you wait until the sauce gets really thick then you’ll have a very sticky situation on your hands even after the fire is put out.  Experience is the only answer to this dilemma, but barring something catastrophic, you should always be able to eat your mistakes.

This mess in which the world currently finds itself is another sticky situation, cooked up by the global banking system using debt and leverage as the main ingredients.  I’m not heaping all the blame on them though.  Everyone who asked for a mortgage, bought a car on time, or otherwise participated in this house of credit cards is culpable as well.  We sat at the table asking for more and the banks just facilitated our appetite.  So now this sauce is definitely stirred up, but nobody seems to know how to quit.  The chefs keep adding ingredients, more debt, but the whole things gets thicker and more unmanageable.  No one running the show today has had enough experience with this debt dish to know just how to put the fire out.  The end result is rapidly becoming something that none of us would ever, or could ever, be able to swallow.

Pandora’s Hydra

Monday, November 21st, 2011

The Greeks sure had a way with words, and a very active imagination. They tell us of the first woman, a lass named Pandora, who was designed essentially as a curse upon all men. Nevertheless, she had a way about her, plus a box which contained most every evil one could imagine. Curiosity led her to open it and the rest is history since all kinds of bad stuff escaped to forever vex us all. Only hope was left inside when she was finally able to slam shut the lid. Pity.

Then there was the Hydra, a nasty creature with poisonous breath and more heads than you could shake a stick at. If you did manage to cut one off, two grew in its place.

While considered mythological, both seem to be playing a role in current events. If Pandora’s reflection can be seen in the current plight of her countrymen, then the box of evils which has recently been opened has certainly released a series of problems. As the two-year struggle to get them all hidden somehow back in a box seems ever more futile, unfortunate consequences continue to grow. Like the Hydra’s poisonous breath they waft across all of Europe and each financial institution within the many-headed banking system of which the European Union is currently comprised is beginning to fear a liquidity crisis that could cut it off from the rest. The world as a whole watches as the EU undertakes the Herculean task of preventing the decapitation of one bank from leading to the emergence of a multitude of other collapses.

The Greeks are also credited with many of the earliest classic plays of the Western World. Traditionally these dramas were considered to be inspired by two of the Muses, represented by two masks. The one for happy endings is smiling; the other, which is frowning, points to a tragic conclusion. Events in Europe must play themselves out for awhile yet before we will know which ultimately takes center stage.

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The opinions and forecasts expressed in this email are strictly those of JR Capps and may not actually come to pass.  JR is president of Atlas Indicators Investment Advisors, Inc.  This email is not a recommendation to buy or sell securities, or of any particular asset allocation strategy, since any investment guidelines suggested here are not intended to represent investment advice that is appropriate for all investors. Each investor’s portfolio must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investing time horizon, tax situation and other relevant factors. Before implementing an investment plan, please discuss it with JR or your financial advisor.  Past performance does not guarantee future results.

JR Capps, President
Atlas Indicators Investment Advisors, Inc.
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