Saturday, February 27, 2010

Where We Are Today

Over the past few years I have said our country would be moving through a series of crisis.  During 2007 and 2008 my focus was on the coming financial crisis that would occur due to the real estate bubble exploding.

When the financial crisis finally came in the fall of 2008 it was clear it would bring on the next crisis which was the economy.

Our economy was heavily reliant both on home prices increasing and the side benefits that came with the bubble; housing related jobs, home equity spending, and bank profits.

As a political leader, the correct action to take when a financial bubble bursts is......nothing.  A contraction in the economy and financial sector is a healthy part of the business cycle.  A strong leader will tell the public that banks will fail, people will lose their jobs, and their home prices will fall considerably, along with their stocks.

Once the system was cleansed of the toxic assets and mal-investment, we could start fresh and rebuild with a strong foundation.  It is the equivalent of a forest fire, which is nature's way of making the earth stronger for new growth.

If you look back through history these recessions normally last a year or two, they are incredibly painful, and then the country continues on with its growth.  It has happened to countries all over the world through the last century.

Of course, as you know, that is not what happened.

The government in the fall of 2008 decided to nationalize the banking system, nationalize Fannie and Freddie, nationalize AIG's insurance business, and all the toxic assets inside these insolvent institutions.

The reason for this is not a big secret or shocking; these companies provided the lion's share of campaign contributions to both politcal parties over the past ten years. 

Due to this decision, it is now a clear certainty that we are on the path to the third and final crisis:

The Currency Crisis

Just as the first two were not difficult to see coming, the final crisis is crystal clear ahead of us. 

You can already seeing it taking place in other smaller situations around the world.  The bell that woke up the world to the government debt crisis began in Dubai last fall.  Nothing has been resolved in Dubai and the cost to insure their debt hit a new all time high this week.

It quickly spread to Greece, and has now moved to Portugal, Ireland, and Spain.  The vultures are even flying around Japan as they keep a close eye on the debt situation there.

These countries have increased their government spending to the point where it is impossible to service the debt.  They all tried to step in and increase spending when we entered the global recession.

The same exact thing is occuring in the majority of our US states.  Illinois is nearing bankruptcy and California is right behind.  These two states have the largest populations in the country.

When you take a step back and look at it, it could be viewed as a set of dominoes, with Dubai's debt crisis as the first push.

People ask why we are not having problems servicing our Federal debt burden?

We are!! 

The Federal Reserve is currently printing money and buying our debt to keep us from defaulting.

Greece, Spain, Portugal, Dubai, California, and Illinois do not have a printing press.  That is the only difference.  In fact our Federal debt burden is far, far, worse than any of these locations when you factor in the debt of Fannie Mae and Freddie Mac to the government balance sheet.

The currency crisis has already begun.  It is only visible to the observant eye. 

As well as entering the first stages of the currency crisis, we are already full steam into the economic crisis.  We received a lot more information this week to confirm this unfortunate truth.......

Homes, Goods, and Jobs

Our phony economy is composed of consumers borrowing money and spending it.

In order for them to do that they have to be confident that things are turning for the better.  This is the importance of the government and media propaganda that you see, touch, and hear on a daily basis.

Unfortunately, the consumer confidence number this month plunged from 56.5 to 46.  This was a record month over month drop and is catastrophic for the prospects of our phony recovery to continue much longer.

What could be making the American public not believe what they are hearing on television?  Mabye it's the real world they live in when they turn off the TV.

New home sales this month plunged 11.9% month over month, taking it down to an all time record low of 309K seasonally adjusted annual starts.  This also erases all the gains made over the last year.

If people are not buying new homes, they must be buying existing homes right?

New home sales fell 7.2% from the previous month coming in at 5.05 million.  The previous month's 5.44 million was a 16% drop from the month before that.

Durable goods orders came in horrendous.  Unemployment claims unexpectedly surged.

The recovery only exists in the six figure government jobs and the record banking bonuses.  The rest of America just moves closer to food stamps.

Tuesday, February 23, 2010

Your Savings Account

We received the Case Shiller home price index this morning and it reported the third straight monthly drop in prices.  It appears there was a bottom in home prices that everyone called for: A FALSE BOTTOM.  Things will get much, much, worse as we move forward.  To understand why please read; Why Home Prices Will Fall.

The chart below shows the top in home prices in September 09, and the three straight months we have now fallen:

This week the Congressional oversight panel put out a 190 page report on the commercial real estate market.  The report provides a tremendous amount of information and I will have a full summary prepared for you this weekend.

To give you a little taste in one sentence or less:  The problem is far greater than anyone imagined and no one has a solution.

The commercial real estate collapse which will begin this year will continue to close the doors for hundreds and hundreds of smaller banks throughout the country that have a large exposure to those loans.

Have no fear, however, because the FDIC is going from bank to bank every Friday night and taking over those failed institutions.  The FDIC is also the firm that stands behind and guarantees every savings account for Americans in this country. (Up to $250,000)

So how is the FDIC doing?

We received word this morning that their deposit insurance fund plunged by $12.7 billion in the fourth quarter of 2009, taking it down to NEGATIVE $20.9 billion.

That is correct: The company that insures your bank account officially has no money, and they will continue to plunge further and further into the red.

Have no fear.  The government has already granted them a $500 billion emergency fund that Sheila Blair promised us six months ago would never be touched.

Ah, and here is where it gets fun......

Where will the government get the $500 billion?  They will add it to the deficit.  Let's review the numbers so everyone can keep up:

The banking system is insolvent and is backed by the FDIC which is also insolvent.

The FDIC is backed by the Federal Government who is currently bankrupt. ($13 trillion in debt, plus $60 trillion in social security and medicare promises)

The Federal government not only has to now provide for the FDIC, but they will have to come to the aid of the state governments who are now also insolvent.  This is in addition to supporting the entire housing market through Fannie and Freddie who will need trillions in bail out money.

The Federal government this morning announced a Supplementary Finance Program that will sell an additional $200 billion in government debt over the next 8 weeks to help cover the exploding deficit.

Before someone could even ask how this debt will be financed with foreign creditors all running away from the United States, a treasury official announced:

"We're committed to working with the Federal Reserve to ensure they have the flexibility to manage their balance sheet."

Please read that quote again, and again, and again.

Charlie Munger

Warren Buffet is perhaps the greatest invester of all time and probably the most well known name in financial history.  He has built a vast empire through company aquisition.

What is less known is that Buffet was only able to acomplish this with the help of a right hand man who was with him from the beginning.  Many feel that this man's genius is equal to the oracle from Omaha.

His name is Charlie Munger, and in very rare fashion he took some time this week to write an article describing the state of America titled, "Basically, It's Over."

I couldn't agree more.

Monday, February 22, 2010

The Clock Is Ticking

A major portion of my focus here over the past few weeks has been on the Fed's treasury purchase program coming to an end next month.

So, what exactly is at stake if the Fed keeps their word and stops buying?

The following chart shows the rates for 30 year treasury bonds over the last few years.  A 30 year treasury bond means you lend the government money and they will give you an interest payment every year for 30 years and at the end of that term you get your original investment back.

The current rate as you can see has risen up to around 4.5%.

The chart has formed what technicians like to call a "head and shoulders" pattern.  You can see the large head coming down on the chart with its two shoulder on either side.  This usually means a strong break is coming one way or the other.  If interest rates rise just a bit further, breaking through the red resistance line, it could be up, up, and away on rates.

So, like I asked earlier, what is at stake if rates were to rise?

In a word: everything.  Let's go through some of the major effects:

1.  The cost for the government to borrow money, the lifeblood of our economy, would rise significantly.  We would have to borrow more to pay for this increased cost.  How much more? I discussed that topic last weekend in an article titled, "Obama's Credit Card Interest."

2.  Mortgage rates would rise as well since they are linked directly to the 30 year bond rate.  Remember, mortgage rates today are at all time historical lows.  They have nowhere to go but up.

With the median price home today at $178,000, the cost of a mortgage loan is $861.  If mortgage rates were to rise just 1% it would increase the loan cost to $962.  If they were to rise 2%, it would cost $1,068 per month.

If they were to rise to their historical average of 10% it would double the mortgage payment for any new buyers of homes, crushing the market values.  This scenario is not only possible, but would happen rather quickly if the Fed and the government were to remove themselves from the housing market.

3.  Over the past 7 months the average American has left the stock market and piled into bonds.  They have been told by their financial advisors that bonds provide a "no risk" investment. 

US households today own $801 billion in treasury bonds, $979.5 billion in municipal bonds (state and local government bonds), and $2.4 trillion in corporate bonds.

If rates rise it pushes the value of these assets down and would have a similar effect to the slaughter seen in the stock market crash of 2008.

These three consequences of rates rising are why I believe the Federal Reserve will not stop buying the treasuries.

They will print, and they will buy. .

If you believe Bernanke then I would be heavily shorting long term bonds.  If you don't believe him and think he will continue buying, then I would be loading up on gold.

Or you can do both, which is the favorite strategy today for the hedge fund legends.

Elizabeth Warren

Sunday, February 21, 2010

Countdown To March

The Federal Reserve is now 95% of the way through the purchases they announced last March for treasury bonds and mortgages.  Both programs, we have been told, will end next month.

The following graph shows the impact on mortgage rates when the announcement was made last March:

Expect both treasury bond and mortgage rates to rise significantly when (or if) these programs end.