Wednesday, April 29, 2009

"Bankster" Persecution Set to Escalate

Since the start of the crisis, new words have entered into the mainstream vocabulary. In 2007, we learned what "subprime" really was. In 2008, the word du jour was "bailout." The competition is fierce and the candidates are many for words that will be newly constructed to describe the current situation.

Corporate "restructuring"?

"Public-Private Partnership"?

Or how about "bankster"?

If I had to choose one of them, I'd throw my weight behind the latter. The screws are really being turned on the banking elite and before the year is out, I'd wager to guess that many of these billionaire CEOs will be on their way to the slammer.

Anyone who was paying attention knew that there was massive amounts of fraud going on in the last year. But the people who typically ask questions of such matters were largely silenced or marginalized while it was happening. Most others simply turned away, falling for the "if it isn't done then the sky will fall" excuse. But now that the average person can see the economy collapsing around them anyway, they are sharpening their teeth and looking back at what actually transpired (and is still transpiring) for hints of a scapegoat.

And the accusations and evidence are starting to pour out. We learned last week that Hank Paulson, Ben Bernanke, Ken Lewis and likely others were involved in securities fraud over the Bank of America takeover of Merrill Lynch. Merrill was taken over in September by BoA in an attempt to avoid another Lehman-like collapse. The deal was for an approximate $50 Billion in BoA stock.

I would argue that the takeover alone was a blatantly poor decision, and it could probably be proven quite easily that Lewis was not acting in his shareholder's best interest in the purchase. Bear Stearns had already been taken in by JP Morgan, and Lehman was on the brink of collapse as well. It is not unreasonable to conclude that Lewis could have procured the assets at a far cheaper price had he only waited a few more days. And we even have precedent to prove that he could have because Barclay's Bank and Nomura Holdings purchased the Lehman assets only days later for a fraction of what Lewis paid for similar assets at Merrill.

But that is not even the issue.

The issue is that 3 months later, BoA had a chance to really look at the toxic soup of assets that they had purchased. What they found was not all that inspiring. Luckily for them, there was a clause in the takeover contract that allowed them to back out of the deal if there was a Material Adverse Change (MAC) in the asset. BoA had determined that the $50 Billion purchase price was far too high and that they would invoke the MAC clause to back out. But upon Lewis telling this to Paulson and Bernanke, he was then threatened with his job along with the jobs of his entire board of directors. Lewis' response was then to "deescalate" the situation. In other words, do as Paulson and Bernanke said in order to save his own hide.

It is without a doubt that if the alleged is what actually transpired (and the allegations are confirmed by the subjects themselves), then Lewis is guilty of defrauding his shareholders and Paulson, Bernanke, plus whoever else were present at these meetings (most likely including Tim Geithner) are guilty of conspiring to commit fraud.

It is with this information that the New York Attorney General Andrew Cuomo wrote a letter to the Senate, Congress, SEC and Congressional Oversight Panel last thursday.

I think that this is a fairly significant event. Enough so, that I have copied the entire document below: (emphasis is all mine).

Dear Chairpersons Dodd, Frank, Schapiro and Warren:

I am writing regarding our investigation of the events surrounding Bank of America's merger with Merrill Lynch late last year. Because you are the overseers and regulators of the Troubled Asset Relief Program ("TARP"), the banking industry, and the Treasury Department, we are informing you of certain results of our investigation. As you will see, while the investigation initially focused on huge fourth quarter bonus payouts, we have uncovered facts that raise questions about the transparency of the TARP program, as well as about corporate governance and disclosure practices at Bank of America. Because some matters relating to our investigation involve federal agencies and high-ranking federal officials charged with managing the TARP program, we believe it is important to inform the relevant federal bodies of our current findings. We have attached relevant documents to this letter for your review.

On September 15, 2008, Merrill Lynch entered into a merger agreement with Bank of America. The merger was negotiated and due diligence was conducted over the course of a tumultuous September 13-14 weekend. Time was of the essence for Merrill Lynch, as the company was not likely to survive the following week without a merger. The merger was approved by shareholders on December 5, 2008, and became effective on January 1, 2009.

The week after the shareholder vote -and days after Merrill Lynch set its bonuses Merrill Lynch quickly and quietly booked billions of dollars of additional losses. Merrill Lynch's fourth quarter 2008 losses turned out to be $7 billion worse than it had projected prior to the merger vote and finalizing its bonuses. These additional losses, some of which had become known to Bank of America executives prior to the merger vote, were not disclosed to shareholders until mid-January 2009, two weeks after the merger had closed on January 1, 2009.

On Sunday, December 14, 2008, Bank of America's CFO advised Ken Lewis, Bank of America's CEO, that Merrill Lynch's financial condition had seriously deteriorated at an alarming rate. Indeed, Lewis was advised that Merrill Lynch had lost several billion dollars since December 8, 2008. In six days, Merrill Lynch's projected fourth quarter losses skyrocketed from $9 billion to $12 billion, and fourth quarter losses ultimately exceeded $15 billion.

Immediately after learning on December 14, 2008 of what Lewis described as the "staggering amount of deterioration" at Merrill Lynch, Lewis conferred with counsel to determine if Bank of America had grounds to rescind the merger agreement by using a clause that allowed Bank of America to exit the deal if a material adverse event ("MAC") occurred. After a series of internal consultations and consultations with counsel, on December 17, 2008, Lewis informed then-Treasury Secretary Henry Paulson that Bank of America was seriously considering invoking the MAC clause. Paulson asked Lewis to come to Washington that evening to discuss the matter.

At a meeting that evening Secretary Paulson, Federal Reserve Chairman Ben Bernanke, Lewis, Bank of America's CFO, and other officials discussed the issues surrounding invocation of the MAC clause by Bank of America. The Federal officials asked Bank of America not to invoke the MAC until there was further consultation. There were follow-up calls with various Treasury and Federal Reserve officials, including with Treasury Secretary Paulson and Chairman Bernanke. During those meetings, the federal government officials pressured Bank of America not to seek to rescind the merger agreement. We do not yet have a complete picture of the Federal Reserve's role in these matters because the Federal Reserve has invoked the bank examination privilege.

Bank of America's attempt to exit the merger came to a halt on December 21, 2008. That day, Lewis informed Secretary Paulson that Bank of America still wanted to exit the merger agreement. According to Lewis, Secretary Paulson then advised Lewis that, if Bank of America invoked the MAC, its management and Board would be replaced:

"[W]e wanted to follow up and he said, 'I'm going to be very blunt, we're very supportive on Bank of America and we want to be of help, but' --as I recall him saying "the government," but that mayor may not be the case -"does not feel it's in your best interest for you to call a MAC, and that we feel so strongly," --I can't recall if he said "we would remove the board and management if you called it" or if he said "we would do it if you intended to." I don't remember which one it was, before or after, and I said, "Hank, let's deescalate this for a while. Let me talk to our board." And the board's reaction was of "That threat, okay, do it. That would be systemic risk." "

In an interview with this Office, Secretary Paulson largely corroborated Lewis's account. On the issue of terminating management and the Board, Secretary Paulson indicated that he told Lewis that if Bank of America were to back out of the Merrill Lynch deal, the government either could or would remove the Board and management. Secretary Paulson told Lewis a series of concerns, including that Bank of America's invocation of the MAC would create systemic risk and that Bank of America did not have a legal basis to invoke the MAC (though Secretary Paulson's basis for the opinion was entirely based on what he was told by Federal Reserve officials).

Secretary Paulson's threat swayed Lewis. According to Secretary Paulson, after he stated that the management and the Board could be removed, Lewis replied, "that makes it simple. Let's deescalate." Lewis admits that Secretary Paulson's threat changed his mind about invoking that MAC clause and terminating the deal.

Secretary Paulson has informed us that he made the threat at the request of Chairman Bernanke. After the threat, the conversation between Secretary Paulson and Lewis turned to receiving additional government assistance in light of the staggering Merrill Lynch losses.

Lewis spoke with individual Board members after his conversation with Secretary Paulson. The next day, December 22, 2008, the Board met and was advised of Lewis's decision not to invoke the MAC. The minutes of that meeting listed the key points of Lewis's calls with Secretary Paulson and Chairman Bernanke:

"(i) first and foremost, the Treasury and Fed are unified in their view that the failure of the Corporation to complete the acquisition of Merrill Lynch would result in systemic risk to the financial system in America and would have adverse consequences for the Corporation; (ii) second, the Treasury and Fed state strongly that were the Corporation to invoke the material adverse change ("MAC") clause in the merger agreement with Merrill Lynch and fail to close the transaction, the Treasury and Fed would remove the Board and management of the Corporation; (iii) third, the Treasury and Fed have confirmed that they. will provide assistance to the Corporation to restore capital and to protect the Corporation against the adverse impact of certain Merrill Lynch assets: and (iv) fourth, the Fed and Treasury stated that the investment and asset protection promised could not be provided or completed by the scheduled closing date of the merger, January 1, 2009; that the merger should close as scheduled, and that the Corporation can rely on the Fed and Treasury to complete and deliver the promised support by January 20, 2009, the date scheduled for the release of earnings by the Corporation. "

The Board Minutes further state that the "Board clarify[ied] that is [sic] was not persuaded or influenced by the statement by the federal regulators that the Board and management would be removed by the federal regulators if the Corporation were to exercise the MAC clause and failed to complete the acquisition of Merrill Lynch."

Another Board meeting was held on December 30, 2008. The minutes of that meeting stated that "Mr. Lewis reported that in his conversations with the federal regulators regarding the Corporation's pending acquisition of Merrill Lynch, he had stated that, were it not for the serious concerns regarding the status of the United States financial services system and the adverse consequences of that situation to the Corporation articulated by the federal regulators (the "adverse situation"), the Corporation would, in light of the deterioration of the operating results and capital position of Merrill Lynch, assert the material adverse change clause in its merger agreement with Merrill Lynch and would seek to renegotiate the transaction."

Despite the fact that Bank of America had determined that Merrill Lynch's financial condition was so grave that it justified termination of the deal pursuant to the MAC clause, Bank of America did not publicly disclose Merrill Lynch's devastating losses or the impact it would have on the merger. Nor did Bank of America disclose that it had been prepared to invoke the MAC clause and would have done so but for the intervention of the Treasury Department and the Federal Reserve.
Lewis testified that the question of disclosure was not up to him and that his decision not to disclose was based on direction from Paulson and Bernanke: "I was instructed that 'We do not want a public disclosure. '"

Secretary Paulson, however, informed this Office that his discussions with Lewis regarding disclosure concerned the Treasury Department's own disclosure obligations. Prior to the closing of the deal, Lewis had requested that the government provide a written agreement to provide additional TARP funding before the close of the Merrill Lynch/Bank of America merger. Secretary Paulson advised Lewis that a written agreement could not be provided without disclosure.

Lewis testified that there was no discussion with the Board about disclosure to shareholders. However, on the night of December 22, 2008, Lewis emailed the Board, "I just talked with Hank Paulson. He said that there was no way the Federal Reserve and the Treasury could send us a letter of any substance without public disclosure which, of course, we do not want."

The December 30 Board meeting minutes further reflect that Bank of America was trying to time its disclosure of Merrill Lynch's losses to coincide with the announcement of its earnings in January and the receipt of additional TARP funds: "Mr. Lewis concluded his remarks by stating that management will continue to work with the federal regulators to transform the principles that have been discussed into an appropriately documented commitment to be codified and implemented in conjunction with the Corporation's earning [sic] release on January 20, 2009."

It also bears noting that while no public disclosures were made by Bank of America, Lewis admitted that Bank of America's decision not to invoke the MAC clause harmed any shareholder with less than a three year time-horizon:

"Q. Wasn't Mr. Paulson, by his instruction, really asking Bank of America shareholders to take a good part of the hit of the Merrill losses?

"A. What he was doing was trying to stem a financial disaster in the financial markets, from his perspective.

"Q. From your perspective, wasn't that one of the effects of what he was doing?

"A. Over the short term, yes, but we still thought we had an entity that filled two big strategic holes for us and over long term would still be an interest to the shareholders.

"Q. What do you mean by "short-term"?

"A. Two to three years."

Notably, during Bank of America's important communications with federal banking officials in late December 2008, the lone federal agency charged with protecting investor interests, the Securities and Exchange Commission, appears to have been kept in the dark. Indeed, Secretary Paulson informed this Office that he did not keep the SEC Chairman in the loop during the discussions and negotiations with Bank of America in December 2008.

As this crucial recovery process continues, it is important that taxpayers have transparency into decision-making. It is equally important that investor interests are protected and respected. We hope the information herein is useful to you in your federal regulatory and oversight capacities and we remain ready to assist further in any way. We also note that we have been coordinating our inquiry with the Special Inspector General for the Troubled Asset Relief Program, whose investigation also remains open.


Andrew M. Cuomo
Attorney General of the State of New York

cc: Neil Barofsky, Special Inspector General, Troubled Asset Relief Program

What I found interesting is that Cuomo wasn't even investigating these charges. He was investigating fraudulent bonus payments that Merrill Lynch had made in advance of the deal closing on January 1. In the course of his investigation of those charges, he stumbled across this even greater issue. This is the problem with compulsive lying and deception. Eventually, one loses track of all their deceptions. And in the act of trying to defend oneself against allegations of one lie, one will often incriminate themselves of another. Such is the case here.

Lewis and the entire board of Directors of Bank of America have acted in complete dereliction of their duty to shareholders. This is of course no surprise to anyone reading this blog. We have known for a long time that shareholders are of little concern to company CEOs - especially those in the financial services industry. The degradation of principles has been going on for decades. Companies would be sold off or acquired solely for the bonus provisions given to executives upon completion. Company profits would be used to buy back stock as opposed to paying dividends to shareholders - and the buybacks would coincidently align with the expiration of executive stock options. Those are just a few of the many examples.

There was little shame on the behalf of executives. But investors didn't really pay much attention because they saw their account statements rising year after year regardless. They rarely bothered to read company releases, attend meetings, or cast votes for management. Collectively, the investors are just as liable for the fraud as the perpetrators. Much like the populace of a country is liable for electing a tyrannical leader. It is their obligation to prevent it from happening - but via pacification campaigns, they can often be convinced to turn a blind eye.

But once the tide goes out (share prices drop, the tyrant turns on his own population) the enormity of the previous complicity becomes apparent to the ultimate victims. They immediately stop their activities and attack the attackers. This letter from the NY Attorney General is an example of that. And it is only the tip of the iceberg. Before this year is over, there will be dozens of similar high profile cases. All along the way, we will uncover such unbelievable arrogance, greediness and negligence that it will make people revile the idea of "investing" in public companies. Mistrust of executives will linger for decades. And I would imagine that many of them will spend the rest of their days either behind bars, poor or both. Sadly, I would venture to guess that the suicide of Freddie Mac CFO David Kellerman will not be the last. Their downfall will be celebrated. They will be sacrificed as kingpins of a morally bankrupt society to which blame should be spread more equitably - but won't.

Stopping to think rationally and pointing out that even the victims were complicit in their own plight will fall on deaf ears. Or worse - the sensible will be grouped in with "the banksters" and persecuted in kind. The only option is to join the rabid masses in their lust for blood.

So what the heck...

"You're good at stealin',
and you're good at lyin',
now let's see how good you are at flyin',
Jump You Fu%#ers!"

Warning: The video below contains excessive profanity

Now I know why Lord of the Flies was required reading in high school.

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Monday, April 27, 2009

Technical Update 15.09

The markets bounced back from a sharp selloff on Monday to finish the week near their highs and frustrate bears even further who believe "it can't go higher." I had been expecting a downward correction to wash out some of the optimism and allow for the market to prove as the "path of greatest frustration" for the most people as possible - a common characteristic of countertrend moves.

My approach continues to be "hands off" as I wait for either of my previously mentioned conditions (time or price) to be met before turning bearish again. Ideally, the market would wind higher in a series of fits and starts for 5-6 months and give all sorts of negative divergences while showing optimism extremes akin to those at the all-time highs. Just like the market did not perfectly accommodate my downward expectations, it will likely not display all of the above when it finally puts in a top. For those wishing to shed some long exposure or add short exposure, it would probably be a good idea to do it gradually, rather than to wait for a certain condition to be met and flip everything around at once.

The S&P has proved resilient a number of times at it's 20 day EMA. A close below that level would communicate to me that strength is weakening and a fairly deep correction could be at hand. It is sitting at 836 and rising. A close below 840 would be my line in the sand if I were toying with the long side (which I'm not).

Do note also that the Nasdaq's relative strength has already brought it in contact with its 200 day EMA. That alone does not mean anything. But used in combination with other indicators, a strong rejection of price from that level could be telling us that it's time for a rest.

The Emerging Markets appear to be showing signs of potential negative divergence after being among the strongest market sectors of the last 6 months.

The Euro/Yen cross has proven to be a useful tool for assessing risk appetites. As the markets have carried higher in the last few weeks, the Euro has been weakening relative to the Yen. This could be yet another fly in the ointment for a continuation of this push.

Gold had a fairly strong week. My expectation is still for lower prices into the summer.

That's all for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Thursday, April 23, 2009

Timing the Depression

The question has been asked for 2 years nonstop. Seemingly no other question can be answered without first addressing this one. We hear it in the media. We see it in the eyes of the shopkeeper. Many now feel it in their own pocketbooks.

"When is this all going to end?"

I remember receiving flak for throwing around the "D" word in late 2008. "Your analysis would have more credibility if you ceased using the word 'Depression,'" wrote one reader. "To say our situation is bad is one thing. To call it a depression is irresponsible," commented another.

In Part II of my Themes for 2009, I wrote:

"The rapid decline in asset prices, slowing business activity and subsequent unemployment is going to have grand implications for the overall economy. As the year wears on, the “D” word (depression) will start to become more widely accepted. The consensus view for a second half recovery will be pushed back yet again as it becomes apparent that monetary stimulus is having little effect on the credit markets."

Nary a day passes now, only 4 months into the year, without an encounter with the Depression analogy. The "D" word is being thrown around like the "F-Bomb" at a Hip-Hop festival. Most economic indicators have surpassed their extreme levels of previous recessions, so the only comparison left is the Depression. Others don't have statistics that go back that far. And a few even give indications that what we are experiencing now is worse than the 30's, providing a "come to Jesus" moment for the economist analyzing the data. "I'm not sure what this means," is the typical response.

A sobering report was put out a couple of weeks ago titled, "A Tale of Two Depressions" by economists Eichengreen and O'Rourke. Instead of simply comparing the US experience of now to the 30's, the pair instead decided to look at the global impact. Considering the Great Depression and today's predicament are both global phenomena, I though this was a reasonable exercise. From the article:

This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences.

Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.

In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then

And now three charts that accompanied their report. Note: in each chart the X-Axis represents months from the peak.

The first is global industrial production.

The second is global stock prices.

And this is global trade.

They go on to explain that public policy responses have been swifter this time around. But whether that has any effect on the economy is a matter of intense debate that has raged on for decades. Keynesians constantly point to any intervention that has failed as "insufficient." It is a clever argument that cannot ever really be refuted. Presumably, they will say that this round of interventionism was also insufficient upon its inevitable failure. In their mind the potential for "stimulus" is infinite.

Regardless, what is clear is that today's economy, if measured globally, is collapsing at a trajectory faster than that of the 30's. It is commonly held that the Smoot-Hawley tariffs are the cause behind the collapse in global trade of the 30's. Yet trade is collapsing at a much faster pace now without such protectionism. I should mention however, that our economy today and the economy of the 30's are composed differently. We were primarily an agrarian economy back then, based mostly on production. Today, we are a consumerist economy, based mostly on debt. I'll leave it up to you to determine whether that is more beneficial or detrimental. But the answer might not be as obvious as it looks on the surface.

The IMF was also out this week with some dire warnings. They now suggest that the total credit losses are to top $4 Trillion Dollars. Only $1.2 Trillion have been acknowledged thus far. They were also kind enough to tell us what we already knew: that the world as a whole is in recession - a feat not accomplished since WWII. Below are a few charts they used in conjunction with their report:

The only ones surprised by this activity are, once again, the Keynesians. They held all along that the amount of debt didn't matter. Unfortunately, these are the same people in charge of government and central bank monetary policy. They are the same people in charge of our financial institutions. And they are the same people (primarily) who are teaching our children about how to engage in business. I hate to sound like a broken record. But anytime I attempt to dodge the issue in favour of non-partisanism, I feel like I'm doing my readers a disservice. So when trying to determine how much worse the economy will become, I would be remiss not to mention that people in positions of influence will be doing everything in their power to ensure recovery is delayed.

An economy based on reality would never have become so debt-dependent in the first place. But in the absence of their constant interventionism, we could have conserved the remaining amount of capital we did have for productive uses. We could have wiped out trillions worth of uncollateralized debt at the expense of the arrogant investors who bought it. And we could have allowed asset prices to fall to natural levels, where the aforementioned savings were sufficient to service the lower amount of debt. It would have been a terrible experience. Unemployment would have rocketed to 15 or 20%. Total GDP would have fallen by a commensurate amount. But at least there would be a relatively low tax rate, a stable government and competent people would have taken over the reigns of poorly run industries. Instead we have the opposite. And guess what? Unemployment is already approaching 15% (if measured properly) and GDP will likely lose at least 5% this year while flatlining for a year or two thereafter (if you are to believe the polyannas). To put it another way, the amount of capital required for debt servicing as a percentage of total GDP is being propped up, thus sacrificing capital that could be used to invest in productive endeavors and strangling the economy.

But not only do we have incompetent policy-makers poisoning the economy with their "debt does not matter" ideology, there are other sections of the economy that are imploding with a lag. Commercial Real Estate is one I've often written about. And right on time, the evidence is pouring in. We learned this week that Q1 retail vacancies surpassed those of the entire previous year. Office and hotel occupancy rates are not doing much better. We also learned of the long awaited bankruptcy of General Growth Properties. GGP owns owned more than 200 shopping malls. What price will their creditors fetch for the properties when put up for sale? And what will this added supply do to the resale values of other properties? How will the GGP bankruptcy affect other REITs in refinancing their debts?

We are also learning that notices of defaults are rising in some of the most hard-hit areas of the residential markets. Foreclosures had moderated due to state moratoriums, but as soon as the moratoriums expired, we have spikes in activity. Again, the interventions are counter-productive, because a swath of properties will hit the market simultaneously, thus pressuring prices even more - resulting in more underwater homeowners and more foreclosures. But now new sectors of the mortgage market are getting creamed. I warned of this in 2007. It is not only the low income areas experiencing defaults. Mid and high income areas are now feeling the pain. Consider the chaos that a 25% price cut has caused for bank balance sheets. Now consider that prices are still falling and notices of default are still rising from their already record levels. Consider that it takes many months thereafter before a) banks repossess the property and b) they write down the value of the loan. How absurd does it sound that we're being told that banks are now on the mend and reporting profits?

Which leads to my next gripe: Timmy Geithner's bank stress tests. I've been meaning to comment on this for a long time. But every day the tragic comedy unfolds a little more and the absurdity of the exercise grows. This week, the subjects of the tests (yes, the banks themselves) are publicly debating what information should be revealed and to whom. I don't know whether to laugh or cry. But I do know what I won't be doing. I won't be taking the results of these tests any more seriously than I plan to take Will Farrell's forthcoming film, "Land of the Lost." Now before you jump to conclusions and picture Farrell playing the role of Tim Geithner in a captivating drama, let me assure you that Land of the Lost is not about the goings-on inside the Treasury Department - as appropriate as that may sound. It's about time travel and terrifying dinosaurs.

But to call this exercise "absurd" is giving it too much credit. First, as Yves Smith has been pointing out since it was announced, it is not even possible that the team of investigators can conceivably do a thorough enough job in the amount of time they've been given. It took a team of ~120 6 months to untangle Citigroup's commercial real estate exposure alone in the early 90's. We're being told that 200 can dissect the entire books of 19 banks in 2 months.

Second, the stress test's "more adverse" scenario assumes positive growth by the 4th quarter of this year and unemployment rising no higher than 10.4% anytime before 2011. Their idea of adverse closely aligns with mine - but only after drinking a gallon of kool-aid and wearing rose-colored glasses.

Third, and I'll cut this short, because I could go on all day. Banks only appear to be showing treasury officials what they want them to see and it does not appear that we will learn of any of these results in a transparent manner. They know that if they present a list of "healthy" banks, people will automatically assume that the others are doomed. And if they give comprehensive results, people will reverse engineer them to match real adverse economic situations - which will obviously tell us what we already know: most, if not all, of these banks are technically insolvent and require capital in the many trillions of dollars just to stay afloat.

In summary, the stress tests are a total charade. And there is no possible outcome that could prove "successful." If they report that all the banks "pass" nobody will believe them. If they release partial results, people will call their bluff. And if they tell the truth, people will panic. Timmy would have been better off doing nothing. But he felt like he had to do something. The first time he held a press conference without the perception of "a plan" the market fell faster than Britney Spears' career.

I could also go on and on about the accounting shenanigans taking place with Q1 bank earnings. But I will save myself the premature rise in blood pressure that further elaboration on that hoax would cause. Readers can simply visit any of the links to the right of this page and find damning condemnations, calls for resignations, and shocking exposés. Prepare to be appalled.

I continue to believe that the best way to measure this depression is not by magnitude, rather by time. I don't believe there is a certain unemployment level or stock market decline that one can point to and declare a bottom based on historical precedent. But once social preferences have altered themselves sufficiently (and probably overshoot on the side of frugality), the savings rate rises enough, and an entrepreneurial spirit replaces the "get rich quick" mentality of asset accumulation, we will have the foundation for a recovery. At this rate, that could take a decade or more.

It could have been different if our leaders had shown some backbone. But they all proved to be cowards. Every last one of them. Rudd, Brown, Harper, Bush, Obama - even their political adversaries. They had the opportunity to expedite this change. They could have proved themselves to be actual leaders. They could have told us, "this is going to be difficult - buckle down." But no, they had to keep up the image that nothing was wrong. They all elected to be con-men. "Confidence men." Instead of listening to the people who predicted that this would happen, they have chosen to listen to those who promised it was impossible. People like Professor Greg Mankiw of Harvard University and former chief economic advisor to President Bush. Professor Mankiw thought it prudent to let this "fantastic" idea be known to the public so he wrote about it in The New York Times:

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to [make holding money less attractive].

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.

This is a professor at Harvard University. These are our best and brightest? Advocating theft in order to coerce people into spending their money rather than saving it?

The question I am trying to answer is, "when is this all going to end?" I suppose that depends on how long we tolerate people like Mankiw passing off idiocy as policy. Because if we leave it up to them, we have the ability to turn what could be a healthy restructuring of our economy into a decades long period of progressively worse fundamentals accompanied by famine, disease and most likely war.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Tuesday, April 21, 2009

Against Empirical Analysis

My writing is often criticized for not being empirical enough. That is intentional.

Although I will often use statistics and charts to affirm my opinions, my opinions are not originated from statistics and charts. This is a fundamental departure from neoclassical economic analytics that suggest economics is a science that can be modeled with a complex equation, and is more compatible with Austrian Theories that argue economics is an art which is based on the ever changing preferences of individual actors.

This is why I have zero hesitation in labeling people with years of formal education, PhD's, Nobel Prizes and other such qualifications as "incompetent." If someone were to critique a painting for not conforming to a certain set of quantified consumer colour, shape or texture tastes, they would be quickly banished for uttering such blasphemy. But the art of economics has been hijacked by people who believe there is such a "perfect painting." There is not. And the events of the past two years demonstrate this better than ever before. If a person with little more than an internet connection and a library card can massively outperform people with Harvard educations and "predictive models" that cost millions of dollars to create, how can one conclude otherwise?

By the time this crisis has run it's course, the notion of economics as a science will be turned on it's head. The General Equilibrium Theory, The Efficient Market Hypothesis, Game Theory and many others will be resigned to the trash heap of history where they belong.

It is for this reason specifically that I seek out opinions of people who have no formal education in economics. People who have no preconceived notions of what "should" result from a combination of certain actions. People who instead look first at the underlying changes in society and then share their analysis of whether a certain influence will result in any number of potential outcomes. I suspect that readers of this blog seek out the same analysis and that is why a steadily increasing number of readers are willing to devote their attention to a 26 year old with little more than an internet connection, a library card and a dash of humility (on occasion).

Nobody attempts to debate the existence of substantial changes in social action over the decades. Anyone who was around in the 60's saw this with their own eyes. Those who weren't don't need to go far for evidence. Simply look at archive photos of pop icons like The Beatles.

This photo was taken in 1965, following the release of "Help!" Notice the clean cut, preppy style of dress, and "moptop" hairdoo.

Now look at the same kids less than two years later following the release of "Sgt. Pepper's Lonely Hearts Club Band" in 1967. Multi-cloured suits, scruffy hair, and mustaches.

What happened? Social change happened. A new generation grew out of their over-protective WWII parents and began to rebel against anything that resembled the values of old. A world of technological advancement and rising standards of living was not compatible with racial or gender inequality. It just did not make any sense to the younger generation. So they fought to change it. The economy struggled for 16 years to adjust to the demands of adding women to the workforce and to provide a new array of goods and services for a generation with different values and demands than those previous.

People have no problem understanding these types of historical changes. Yet when confronted with the excessive problems we face today, academics and average folks alike cannot envision a period of similar change. They cling to what they know; to what is comfortable. They cannot comprehend what a recovery would look like without rising debt levels, a revival of the housing market, busy shopping malls and a new consumer fad. All they know is a steady progression towards bigger, louder, shinier. The trend has become a defining characteristic of their very existence.

Even when the evidence is staring them in the face, they refuse to believe it is over; that it is not coming back. Take for example this article from USA Today that has garnered quite a bit of attention:

When the economy started to squeeze the Wojtowicz family, they gave up vacation cruises, restaurant meals, new clothes and high-tech toys to become 21st-century homesteaders.

Now Patrick Wojtowicz, 36, his wife Melissa, 37, and daughter Gabrielle, 15, raise pigs and chickens for food on 40 acres near Alma, Mich. They're planning a garden and installing a wood furnace. They disconnected the satellite TV and radio, ditched their dishwasher and a big truck and started buying clothes at resale shops.

"As long as we can keep decreasing our bills, we can keep making less money," Patrick says. "We're not saying this is right for everybody, but it's right for us."

(emphasis mine)

Two years ago people would have thought this family is from another planet. Today, the comments section of the article is full of people who claim to be considering such changes for their own families. And that is just a story of people who have elected to make those changes. There are an equal or greater group of people who are being forced to make them because of job loss, rising debt burdens or falling net worths.

I've been doing google news searches periodically for the world "frugality." The use of the word in news publications has been rising exponentially. This article from a midwest newspaper is one of dozens yielded on a search today.

Frugality is the new black. Throw in the terms "eco-friendly" and "healthier," and the result is a trifecta of hip.
Who knew packing a lunch could symbolize so much?

"It's every penny counts," says Kevin Wehr, an assistant professor of sociology at California State University, Sacramento. "It's expensive to go out to eat, and when people have fewer dollars in their pockets, it's a cheap and easy way to reduce expenses."


Carrie Person of Roseville, Calif., packs a thermal-insulated case of food for her husband, a software salesman, every night before going to bed.

"He leaves for work really early," she explains.

Person, 33, varies yogurt flavors, sandwich meats, breads, even mustards, she says. Her husband used to be chastised for being a frugal foodie in the office, but he now looks like something of a trendsetter.

"His co-workers used to tease him about bringing his lunch," Person says. "Now, a lot of them are starting to do it as well."

Everywhere one looks, one can see signs of current and impending societal change. Even in popular culture. Surely most of my readers have been made aware of Susan Boyle's performance of "Dreamed a Dream" on the reality show Britain's Got Talent. Boyle is a 47 year old frumpy Scottish woman who's previous life achievements include caring for her aging mother and church volunteering. She has never held a serious job. One fairly mean-spirited summation of her appearance I saw was that "she appears to have fallen out of the ugly tree and hit every branch on the way down."

John Xenaxis at Generational Dynamics had a very interesting review of her performance, but his site is having difficulties at the moment. As John pointed out, it is not really the performance that is significant. It is the reaction to the performance. The online video I linked above is one of many whose total views have set new internet records and tally in the 100's of millions if put together - only 10 days after first being heard.

Why is this important? Plenty of less than supermodel quality singers have won contests. It is important because it demonstrates the changing social values in our society. People are ready to cast aside the old paradigm values characterized by sickly thin, botoxed women toting around shopping bags:

The reaction to Ms. Boyle's performance was not a celebration of a great voice, it was a celebration of the death of an era. An era that no average person wants back. The audience and the hosts intuitively recognized that they were witnessing a singer - not a representation of what a singer should look like. And this reaction is the result of a societal urge to experience what is real and cast aside what is fake. It is the same societal force behind the utter rejection of what was formerly known as our financial system. And it is the same force behind people electing to raise their own livestock or brown-bag their lunches, as opposed to settling for the fast food option.

Kevin Depew has been writing about this topic for years, starting in 2006, and following it up with his article last year titled, "The Crisis of the Real."

Neoclassical analysis has no room for attempting to spot changes in social mood to determine their consequences. Instead they would point to the people making their own lunches as "contributing to a problem of demand deficiency." They would then suggest that the government impose regulations on the sale of food ingredients or to give tax breaks to restauranteurs in order to "bring the market back into equilibrium." In trying to explain Susan Boyle's sudden popularity, the neoclassical economist would grade her appearance on a scale of 1 to 100, and based on the previous success rates of people with a similar appearance, they would assign a probability to the chances of something similar ever happening again. With a straight face, they would look at you and explain that her performance was a 1 in 963 year event and should therefore not warrant any further analysis.

If you are still interested in reading empirical studies of the economy based on statistics, I can provide you with a long list of harvard graduates who have published many university level papers on various subjects.

Alternatively, you could type into your browser window a random acronym followed by ".gov" and are sure to find something along the same lines.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Sunday, April 19, 2009

Technical update 14.09

Week 6 of our "super fantastic new bull market" (to paraphrase CNBC) packed on a few points in all the major indices. The rally in the S&P has now measured 31.3% from the bottom, which is a 23% retracement of the entire Oct '07-Mar '09 move.

Based on the market internals, sentiment indicators and the like, I am sticking with my assessment that this is not the typical quick, shallow bear market rally. Rather, it is a longer, psychological adjustment that will set the stage for a substantial move lower in the latter half of this year and next. It will do so by convincing as many people as possible that the worst is over and blue skies lye ahead.

I'll try to outline the potential targets for the move below. But remember that surprises in bear markets come on the downside. I could dream up a dozen scenarios where the rally is prematurely aborted in favour of a violent move downward. There may be better low-risk opportunities to try and participate in the rally (on a large pullback, for example), but using a tight stop-loss would be a necessity. Trying to jump in now could prove suicidal - even though a buying panic may be near.

S&P 881 - 23.6% Fibonacci retracement of Oct '07-Mar '09 move
S&P 962 - the falling 200 day EMA (would probably intersect 950 after a few more weeks)
S&P 999 - the falling 50 week EMA (would probably intersect 975 by the time price got there)
S&P 1097 - the falling 20 month EMA (would probably intersect 1000 after another 3 months)
S&P 1013 - 38.2% Fibonacci retracement of Oct '07-Mar '09 move
S&P 1050 - Trendline of underside from Aug '07, Jan '08, Mar '08, Aug '08 (downsloping)
S&P 1044, 1007, 943 - October, November and January highs

The same indicators in the Dow or the Nasdaq could prove to be more prominent. It is not the levels themselves, but rather the reaction to the levels that is important. Quite often, the important moving averages will prove too ambitious for a weak market (or will overshoot for a strong one).

I will be watching the performance around 940 for clues as to whether the rally is reaching an end. Ideally, I'd like to see a large pullback in the near term before we got to those levels. Another major factor we should be considering is time. This rally should last longer than just the 6-8 weeks that the other, smaller corrections did. The previous move was 17 months in duration. If the Elliott Wavers are correct in their assessment of this as a "primary wave 2" rally, it should at least come close to lasting 1/3 of that period (or at least 5 months). However, the top could come in the first half of that (soon) and be followed by some chop and failed attempts to surpass it throughout the summer.

If 940-950 is easily surpassed, I just don't see it getting much further than the round number resistance and minefield of other resistance around 1000. But we'll obviously have to cross that bridge if and when we get there. By that time we'll doubtless have a number of positive or negative divergences and sentiment hints to guide us. Again, something that only time can provide. Perhaps we'll be able to find some clues in the Put/Call ratio (a break of the trendline below maybe?)

The Euro looks like a disaster waiting to happen. I'm becoming more and more convinced that the next overall market leg down will be sparked by a crisis in the currency.

The only thing I can find that looks worse than the Euro is Silver.

That's all for now.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Friday, April 17, 2009

Keynesians Fail Stress Test; Backpedal On Ideology

Subsidizing failing institutions does more harm than good. This is the song I and many others have been singing since the beginning of this crisis. And after nearly 2 years of failed attempts to reinflate the bubble, even the big government apologists are now joining the choir.

The façade of government confidence is crumbling. There is simply no way to hide the blatantly obvious any longer. So it should be no surprise that people of still good reputation are electing to jump on the "It Ain't Gonna Work" bandwagon as opposed to the alternative - going down with a sinking ship.

Granted, these characters are not embracing the Austrian Theory of the Business Cycle. But they are at least acknowledging that what has been tried has failed, and attempting to do the same - only on a bigger scale - is not going to have any better chance of success. Baby steps.

Nobel Prize winning neoclassical economist Joseph Stiglitz gave an interview to Bloomberg yesterday echoing some of my sentiments toward those in the Obama Administration. (emphases mine):

The Obama administration’s bank- rescue efforts will probably fail because the programs have been designed to help Wall Street rather than create a viable financial system, Nobel Prize-winning economist Joseph Stiglitz said.

“All the ingredients they have so far are weak, and there are several missing ingredients,” Stiglitz said in an interview yesterday. The people who designed the plans are “either in the pocket of the banks or they’re incompetent.”

It's hard to know what to make of a situation where one minute you feel like the lone voice - written off as sensationalist, while in the next, eminent scholars are repeating you almost verbatim to the national media. Should one be honoured for the indirect affirmation, or skeptical of the motives? More from the article:

The Troubled Asset Relief Program, or TARP, isn’t large enough to recapitalize the banking system, and the administration hasn’t been direct in addressing that shortfall, he said. Stiglitz said there are conflicts of interest at the White House because some of Obama’s advisers have close ties to Wall Street.

“We don’t have enough money, they don’t want to go back to Congress, and they don’t want to do it in an open way and they don’t want to get control” of the banks, a set of constraints that will guarantee failure, Stiglitz said.

The return to taxpayers from the TARP is as low as 25 cents on the dollar, he said. “The bank restructuring has been an absolute mess.”

Rather than continually buying small stakes in banks, weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said.

It would have been nice to have a simple admission from Mr. Stiglitz that the Keynesian policy of economic stimulus was wrong all along, but his admission that "we don't have enough money" is actually another way of saying the same thing. It might not look like much, but that very sensible statement is a damning critique of 100 years of failed economic policy that suggests money grows on trees.

It should come as no surprise that big name economists are pulling subtle about-faces. After being the first to promote government interventionism as the be-all end-all cure for this crisis from day one, they can see how it has so miserably failed and are now faced with the raving mad public. People are fingering bankers, politicians, analysts, economists, the media and anyone that has anything to do with the financial industry.

Wednesday, an estimated 250,000-500,000 took to the streets in anger over wasted money and the rising taxes that will inevitably result from it. No economist wants to be implicated. An economist with a bad public image is an economist without a job.

Despite the media's best attempts to label these "Tea Party" events as a left vs. right thing (controversy sells), the truth of the matter is it is fairly bi-partisan. People are sick and tired of being stolen from and lied to. And even the most sedated (next to Canada of course) country in the world is taking to the streets in anger. Watch this video for not only the media's direct attempts to polarize people, but people catching them in the act and lecturing them on their terrible reporting tactics.

And some pictures from the protests:

Lansing, Michigan

Columbus, Ohio

Sacramento, California

(courtesy Lance Iverson / The Cronicle)

Expect these protests to intensify. And expect the government to cave on their demands eventually. Congressional midterm election campaigns are scheduled to begin in about 6 months. Anyone seen as complicit with government bailouts won't have a hope of being reelected.

Lastly, a prediction. Tim Geithner's position as Treasury Secretary won't hold through the summer. Larry Summers' position as economic advisor likely won't either. We are embarking on a new era of public outrage.

As we should be.

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Wednesday, April 15, 2009

Looking For Relative Weakness

"The greatest trick the Devil ever pulled was convincing the world he didn't exist." -- Keyser Soze

The job of a bear market rally is to convince as many people as possible that the bear is over. The more pessimistic speculators are in the preceding plunge, the more more violent the subsequent rally must be to change their minds.

This holds true for individual stocks, sectors and entire indices. The same goes for corrections in a bull market. It took a massive crash like that of '87 to convince enough people that the bull market was over - immediately before embarking on a 12 year mania.

I've covered where I think this rally will go and how long it will last in my technical updates. But as it progresses, my eyes will shift away from potential long candidates (as I showed back on Mar 3 with "On Bottom Fishing") and toward short opportunities.

In doing so, I will be employing a similar tactic of looking for certain sectors or individual companies that have not participated much in this rally. There are some differences in the method, however. When looking for potential candidates for a bear market rally one should look at the unwillingness of a certain stock or sector to surpass previous lows while broad indices have done so. Or one can look at the total decline from the peak price. But when looking for candidates to lead the next leg of the bear market, I will be looking at the percentage recovery between the peak price and the lows.

In other words, just because financials may have doubled over the last 5 weeks, the recovery is quite mild in comparison to it's peak price. The chart below highlights a number of different indices and sectors along with their percentage recovery from peak prices.

(Note: peak prices for the various indices occurred at different times. Homebuilders peaked in '05. I used '07 peak prices for the Nikkei and Nasdaq - not their absolute peaks many years before)

When used in combination with other indicators, the relative weak recoveries of those on the bottom of this list could be a signal for underperformance during the next leg down. I stress "in combination with..." because any indicator used on it's own is useless. I would also take note of whether or not the security has passed it's early January peak or not, divergence late in the rally, volume and a number of other factors.

As such, my eyes are focused on the utilities, financials, health care and energy producers. I could have also added crude oil and copper to the list above. However, beware that just because these commodities have traded in tandem with the overall economy and markets for quite a while, they won't always do so. Correlations between asset classes often break down as soon as the average person believes they are gospel.

Keep in mind that I do believe this rally has much further to go and will likely be interrupted by a very convincing correction somewhere along the way. How these sectors and the others perform during that correction and the subsequent rally to new YTD highs will be of great interest to me in determining what I will be shorting. As will be the individual sector reactions to earnings reports. Keep your eyes and ears open for bottom callers and steadily rising sentiment indicators. I don't think the coming top will be marked with token analyst bullishness. It will be "common knowledge" that the worst has passed and "happy days" are here again.

I would also note that the next leg down will be characteristically different from the first. I fully expect to see many names go to zero and others to stay relatively buoyant (although relative strength to zero isn't difficult). The retail space specifically has an enormous dichotomy. Some companies like Best Buy (BBY) and Wal-Mart (WMT) have hardly budged while others like ones that rhyme with "Lacy's" and "Mannequin Hands" are looking atrocious. Just because the retail sector has been doing very well of late does not mean there are not opportunities. You have to dig deep to find the weak ones. For legal reasons I won't be doing much of that here (too many bloggers have been served with "anti-defamation" suits for suggesting specific shorts - ludicrous, I know. Apparently free speech is no more).

Is there anything that my readers have their eyes on? Am I missing something in the list above? Can I finish this post without slipping in a little "Go Canucks Go!" nugget?

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Monday, April 13, 2009

The Critical Mass

A critical mass is near. It seems that even the neoclassical economists and pundits now agree that the bailout model of economic recovery has failed and a wholesale change will be necessary. Public opinion is gradually swaying in favour of letting the bankrupt companies go bankrupt. And the truth about how we got into this mess is taking precedent over politicians and their subservient media lapdogs are trying to tell us.

"The problem" has reached a consensus viewpoint. Score one for the side of common sense. "The solution" is being debated and deliberated ad infinitum.

An interesting interview of William Black by Bill Moyers crossed my radar last week. Interested readers may wish to view below:

Neither of these guys would be considered favourites of mine. But I like this interview because it highlights some of the absurdities that went on during the boom years. It was exactly what Black describes it as. Fraud. It was done with impunity. They knew they were doing it and they knew that it would blow up at some point. But they did it anyway. And they lied about the risk all the way. "You're saying our entire financial system became a ponzi scheme?" "Yes."

Unfortunately, Black seems to contradict himself quite a bit in this interview. He states over and over that we have fraud laws that were supposed to prevent "false representation" yet those laws were rarely, if ever, enforced. But he then goes on to say that "more regulation" is the solution. And states some politically partisan populist stuff like "Bush essentially eliminated regulation." Of course, we know that it was not the absence of regulation, rather the corruption of government regulators that led to all the shenanigans. This is something that history has proven correct time and time again. Government regulators are held hostage to those that pay their salaries. Those that pay their salaries are easily influenced by lobbying and campaign contributions that urge turning a blind eye in order to achieve a certain short-term goal (accounting standards prior to earnings season, for example).

The solution obviously isn't to have more of this. It is to actually charge those responsible for fraud to the most punitive extent allowed by the law (life in prison) via judge and jury. Consumer choices will handle the rest of the regulating. If they don't think their savings are safe at a certain bank, they'll pull their money out and put it in another one. The irresponsible bank goes under and the responsible ones gain customers. It works the same way with auto manufacturers or food processors. If people are getting sick from eating a certain food product, they'll stop buying it and the company will go out of business after being sued by those that were made ill. There are very few exceptions (some would argue none) where government regulation can achieve what already written laws cannot.

Another interview I found interesting was Paul Krugman on CNBC last week. I obviously don't agree with much Krugman says. He's what best could be described as a "radical Keynesian." But even he realizes that none of what is being done by the Geithner/Summers/Rubin team are going to solve anything.

I highly recommend my readers have a listen to a 55 minute interview given by Austrian Economist and author Tom Woods on Financial Sense. He discusses with Jim Puplava his new book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. An Mp3 of the interview can be downloaded by right-clicking here. Or you can click here to listen online.

I also found myself in broad agreement with Nassim Taleb's Financial Times article, "Ten Principles of a Black Swan Proof World."

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

Well put, Mr. Taleb. However, I'd like to know whether it is humanly possible for such common sense to last for more than the lifespan of one person? Are we capable of sacrificing short-term gain for long-term pain if nobody has felt what that pain is like and only understands it via the history books? I suppose the answer doesn't matter. Whether our ancestors destroy the checks and balances we set up for them is up to them. For our sake, in this lifetime, we should be heeding your advice.

A cartoon from the Chicago Tribune all the way back in 1934 teaches us one very important lesson: "The more things change, the more they stay the same."

The media would have you believe that those who are outraged enough about all of this to take their anger to the streets are nothing but jobless, lazy, anti-government nihilists. A group of about 200 of these rabble rousers gathered in front of the San Francisco Federal Reserve last weekend to express their misplaced discontent. Don't these anarchists have anything better to do? It's a good thing there were approximately 50 riot police on the scene to quell any disturbances.

Hmm. Upon second look, it appears this band of riffraff is nothing but a cross section of the American middle-class. Fully aware that they are being robbed blind by those who claim to be helping them. But pay no heed to this most natural expression, readers. Don't question authority. Capitalism is to blame for all of your problems and the government is here to help you...

Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.

Sunday, April 12, 2009

Technical Update 13.09

I hope all of my readers enjoyed the long weekend. I personally have hardly glanced at the computer for the last few days. It is very easy to get caught up in the 24/7 news flow that is now available to us. Taking a step back is usually more helpful than harmful in my opinion.

Week 5 of this rally proved to be just as interesting as the previous 4. Thursday greeted us with an earnings "surprise" from Wells Fargo that catapulted the index above levels formerly known as resistance. The 835-845 area now becomes heavy support for an extension higher. I would also note that the S&P, with it's late day push, closed the week above the important 20 wk/100 day EMA. It is the first time it has accomplished this feat since May of 08. But in an effort to see both sides, we will also remember that the 860 area was significant support throughout December. Past support becomes future resistance. That said, I don't expect those levels to hold. The 50 wk and 200 day EMAs should act as a magnet during an earnings season that proves to be "better than expected."

I will be keeping my eyes peeled for negative divergences as (if) the markets carry higher. Currently on my radar are the anemic performances in the utilities and health care sectors. The sectors that do not experience significant recoveries relative to their previous '07 highs will be ripe for leading the market lower. Financials and retail may also fit this bill even though their recoveries have been spectacular - they are still shadows of their former selves. I will have more on this in the weeks and months ahead.

I have discussed the debt problems of the utility sector in the past. If the credit markets do not thaw enough for these companies to refinance their debts, the collapse in common equity of these stocks could be spectacular. They would be forced to cut their dividends - and without those, there is little legitimate reason to own pipeline operators, electricity providers or telecoms companies.

When the next leg of this bear market starts, it will be with a bang. I've discussed the possible shoes to drop could be in the form of commercial real estate or pension funds. We all know that even though banks will be showing profits this quarter, those are not indicative whatsoever of what the garbage on and off their balance sheet is really worth. This lack of transparency is yet another worrisome potential catalyst. But we must bear in mind that it is not necessarily the US that will provide the footwear. It could come from Europe or even Asia.

I'm looking at the performance of the Euro very closely here. When the G20 leaders promised $1 Trillion in additional funding to the IMF, one would think that should have been supportive of the Euro. With hundreds of billions in loans being made in Euros to central and eastern countries, the IMF money is supposedly going to help stabilize that region and protect western european banks from defaulting countries in the east. The continued weakness of the Euro in spite of these developments may be signaling something important.

I have also discussed crude oil as being a decent indicator of increasing optimism in the overall economy. I think it has eyes for the $70-75 range highlighted by the bunching of important EMAs in that area. It made the first important step in achieving those targets by closing significantly above the 20.

In my February 28 Technical Update I asked:

Copper is paying no mind to the rapidly declining economy. It is still sitting 24% above it's December lows. Is "Dr. Copper" forecasting a little improvement?

This proved correct as Copper led and is still leading the surge higher. A 50% correction of the '08 crash would bring it to approximately $2.60/lb - right around where a few key EMAs are sitting.

Platinum has been defiant of the general decline in precious metals prices. It has been performing more as the industrial commodity that it is, so I'm not sure if this should be surprising.

That's all for now.

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