Money Thrown at the Problem

Let’s review the facts, because it will have been two full years since Lehman in September and I think we all (myself included) need a bit of a reality check:

U.S. Treasury

- TARP = $700 billion USD to bail out the U.S. banking system through direct liquidity injections in U.S. banks

- 2009 Government Stimulus = $787 billion USD; Subsidized government and private sector jobs, subsidized state and local services, 14% invested in infrastructure.

- Unemployment Benefit Extensions = $120 billion USD; Eight (8) consecutive extensions of pay to unemployed.

U.S. Federal Reserve

- Total Long Term Treasury Debt Purchases = $753 billion USD; Fed bought 10+ year Treasury notes at auction to support demand for U.S. debt, taking rising pressure off of mortgage rates.

- Total Fannie & Freddie MBS Purchases (08/04/2010)  = $1.12 trillion USD; GSE Mortgage securitization  groups now state owned, as Fed swallows mortgages unfit to remain on GSE balance sheets.

- Federal Funds Rate target at 0.13%; historically unprecedented quantitative easing, which has allowed mortgage rates to ease below 5% on 30-yr fixed products.

When we add up the cash that has been dedicated to the sustainability of our financial market, and thus our economy, we see the following capital commitments:

Treasury = $1.6 trillion

The Fed = $1.87 trillion

America’s Future

It’s clear that if the Fed continues QE and the Treasury continues backing stimulus, the government will end up owning far more once private industries and the population will become dependent on anticompetitive subsidy rationing for survival. It’s been announced recently that over 4o million U.S. citizens are now on Food Stamps.

The other route suggests an imminent recession. Should the Fed and Treasury go the “austerity” path, as Europe has chosen with the leadership of Germany’s cost cutting plan, the most likely outcome would be a recession and repricing of all assets to actual market values.

The recession hurts more in the short term, but guarantees more robust long term growth, while the socialist-esque spending route will land us in an economic environment akin to somewhere in Western Europe.

Of course the Fed is attempting to eat the cake and have it too, by a little slight of hand trick where they announced a reverse repo of MBS on their balance sheet, once abducted from Fannie and Freddie, where they will take money out of the financial system by reselling MBS contracts into the market. However, we don’t know which MBS packages are being sold and which aren’t. Do you see Benny Boy selling bad debt back onto the market? We can assume that the fed is in essence serving as a purifier of bad debt, where they buy the toxic material sort out the rare gems, and sell the good stuff back to the private banks.

FOMC Tuesday

The Street is hesitantly expecting Bernanke to announce some kind of further quantitative easing, which would look something like a resumption to the old MBS purchase program from the GSE’s, which was ended in March. For the Fed to end a QE program in March and resume it in August is more than a bit frightening to this analyst. The Street, of course, is cheering the potential assistance.

If the FOMC Fed announcement tomorrow (Tuesday) includes specific promises of further QE we’ll see a short term rally. IF the FOMC continues to talk abut the economy’s “worse than anticipated” performance, but fails to outline any specific plan to stimulate through monetary policy, we will see as sell-off. In our view, any rally would be stopped cold at 1150 on the S&P 500, as a massive head and shoulders pattern comes to fruition.

Happy Hunting

June 11, 2010:

The Washington D.C. summit in 2008 crowned the Group of Twenty Nations (G20) as the official global economic summit of industrialized countries. Two years in, Korea is proud to have been chosen to Chair the 2010 G20 summit, which was kicked off in Busan last week for a meeting of the group’s finance ministers. Hosting the G20 certainly represents a milestone on Korea’s global economic ascent; however, the communiqué out of Busan begs a dissimilar fate for the unification of the group. In this edition of the Korea Economic Slice on KBC, we’ll analyze the effects of the Busan G20 communiqué on Korea’s economy and take a look at market moving economic data to be released in the week ahead…

Download the FULL report in PDF format HERE…

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Even after the TARP fund liquidity injections in the U.S. financial sector in 2008, the E.U. has decided to bail out one of it’s member states, Greece, from insolvency. How can this even be considered?

Yes, the EU constitution is a whopping 7 years young and therefore demands a minuscule thread of adherence by member states, but it still directly contradicts two clauses of the charter, which stipulate the EU has no role in assuming the debts of any one state or backing the credit of any such state so that it may issue debt.

In making an elementary comparison between the financial meltdown in the U.S. and similar insolvency in weaker E.U. member states, let’s first answer a simple question: “In the case study of financial institutions failing in 2008, who would best represent Greece… Bear Stearns or Lehman Brothers?”

It would seem that the role of the maiden union state to cry “uncle”, akin to Bear Stearns in Spring 2008 at the Hand of then Secretary Paulson, is now cast to Greece. However, looking at the sovereign debt situation as a whole, one could make the argument that it was first the UAE who bailed out the Dubai World Sovereign Fund on Thanksgiving night 2009. For humor’s sake, lets assume that Greece is the Bear Stearns of 2010 and limit our scope to the EU. It is after all a united body making decisions sure to cause repercussions, which will be at least initially contained within its members’ fiscal borders.

So then of course the second major nation to go effectively bankrupt, will be one of the remaining three PIGS (Portugal, Italy, Greece & Spain). Considering the leadership in all remaining states and the tie amongst them for impotence, incompetence and corruption; it could be any of the three. However the next to go will spur a decision a lot like the U.S. Lehman deliberation in 2009.

Whether anyone wants to admit it or not, it’s a good thing that Lehman was allowed to fail in 2009. Yes, I said it… growl and moan all you want, but we needed a shred of moral hazard to keep our capitalist hearts beating and Lehman was the sacrificial pig. Little Timmy Geitner would have danced the populist Obama jig right down the line bailing them out one by one, but luckily Bazooka Paulson was in the midst of a grudge match with on of the largest rivals of his alma mater, Goldman Sachs (GS). The only mistake was to then concede defeat to the frozen credit markets by shuffling around a smoke and mirrors bailout plan which ended up profiting the biggest U.S. banks at the expense of tax payer funded backstops. But we digress…

Unfortunately for the world, France is charging ahead and towing the rightfully reluctant Germans towards TARP 2.0. Germany is by far the most solvent of the EU states and the most crucial to a working bailout of Greece, yet France’s Sarkozy is pulling the reigns. The interesting sub plot here stars the leader of the IMF, the institution that would normally intercede as lender of last resort, no other than a Mr. Dominique-Strauss Kahn, the French contender for Sarkozy’s office in the next election. Alas, its no surprise that Sarkozy wants to go to bat with the tax payer’s dollars rather than admit a fellow EU member is among the ranks of Mongolia, Togo, Haiti, and the long list of states faced with the decision to admit IMF intervention or crumble bankrupt.

So will there be a Lehman equivalent EU state nearing a bond payment one dollar too high and an EU governance that tells them tough luck? Absolutely not. There won’t be a Lehman equivalent in the EU because, (a) countries are more difficult to break up and sell off than firms; (b) the expansive and centrally funded social welfare systems of European states must continue to distribute capital to citizens, lest the union be disgraced by the impoverishment of its constituents; and most importantly, (c) a currency crises due to real or assumed default by any state will have systemically negative effects on the value of the Euro itself, forcing the cost of the central welfare programs to rise across the Union. In turn there will form a negative feedback loop, where the next weakest countries to fail will default and the Euro will become even weaker.

The only option for EU leaders is to bail out as many as all four of the PIGS and hope that China keeps buying goods. If the Chinese engine starts to sputter, the gig is up and we will see one of the most atrocious currency crises in the history of money, beginning with underlying currencies of the sovereigns which have spent the most and recovered the least since the recession began.

The IMF currently has 163 billion SDRs (Special Drawing Rights) available to loan out in the event that a country needs loan assistance. Equating to almost 250 billion USD, the current lending capacity of the IMF could cover the cumulative deficits of the PIGS in 2009 (totaling $198 billion). Yet referring to the visual below, after accounting for the PIGS’ summed liabilities and net debt interest in 2009, the IMF itself may not have large enough reserves to cover the outlays of these four nations, should vacant labor markets continue to stress the fiscal resolve of European social security.

Greece now has the support of France and Germany, but no one really knows how the drama will unfold when the April Bond payment actually comes due. Will Spain face a similar fate as Prime Minister Zapatero grapples to reign in government spending in the face of striking unions and 19% unemployment? Can the economies in Italy and Spain find a way to continue making bond payments should jobs not return before state coffers are drained?

These questions should make for the most current drama in the seemingly bottomless pit of systemic risk. The nasty twin brother of the benefits of interdependency, from economy of scale and scope of multinational firms and massive trade agreements, systemic risk has matured from private markets to macro trade agreements and this time there may be no lender of last resort.

These days death is so 20th century, aging is "faux pas", and failure is completely unacceptable, thus we open up the hood and start pulling wires until we seemingly avoid these outcomes in the short run, leaving plenty of duck tape and WD-40 on the fender if anything should go wrong. 

The U.S. Fed Funds is at 0%, the U.S. Fed absorbed Fannie and Freddie (in effect adding the majority of the nation's housing debt to the Fed's balance sheet), tangible sovereign debt delinquencies are beginning to arise in Europe and the Middle East, and financial firms across the globe are continuing to buckle under the weight of more delinquencies and defaults. Consumer credit reaches new historical lows each month (a good thing in the long run), choking consumers to spend little more than they could in the midst of the market crash of 2008-2009. The dollar has fallen against most foreign currencies, until it's recent rebound on speculation of a Fed Funds raise, releasing cheap money to all of the guys on Bernanke's A list (A short list which excludes mall cap firms and fewer private enterprises).

We all know the story, we all see the mayhem of economic data when we glance in the rear view, we even all expected that the music would eventually stop and the economy would have to walk "freely" by itself. It's the classic leak stopping cartoon where a guy is using one hand to cover a leak in his boat but the pressure just causes another breach and eventually he's out of appendages, but in Bernanke's boat he continues to grow arms and continues to stop leaks. Bernanke is an extremely intelligent and creative regulator who continues to invent Monetary tools to make his puppet dance, but we need a "real boy" not a puppet. When Fed Funds at 0% failed, he gave the banks money to lend, when shareholders panicked he seized the GSE's and secured their mortgages, and now that carry trades have abused excess liquidity in the system he has decided to borrow the 0% money he lent to the "too big to fail" financial firms at a CD level premium. It's a financial shell game no better than a Ponze scheme and the longer it goes on the more money it's going to cost the taxpayers who still don't have jobs.

But it will go on, because that's what the boys upstairs have clearly decided will happen, so the excess liquidity in the system has been the most recent phenomena to be traded off of. The carry trade uses cheap U.S. dollars and invests in risky assets such as stocks, bonds, foreign firms, and commodities; allowing for a booming U.S. stock market among other things. Until the masses became privy to what was making the puppet dance and the carry trade discounted in, Bernanke could enjoy the time he'd bought, but despite the struggling economy it now seems that Obama and his Europe buddies have a new scapegoat for our troubles other than the Fed Chairman.

Relations between Obama's White House and Hu Jintao's Chinese Leaders have been tense at best, as the recent pectoral flexing and anticompetitive trade tactics are squaring Obama and his cronies up against the 1.3 billion strong communist nation. Now, calls for China to re-float the Renminbi (Chinese Yuan), after it was re-pegged to the U.S. dollar in August 2008, are becoming widespread as the economy is poised to grow at rates near 10% and it's cheap goods are undercutting domestic producers across the world. But the Yuan equals the same today in dollars that it did when it was re-pegged in 2008 and it seems that in true faith Obama could save a few taxpayer dollars on the long distance in exchange for a direct line to the Federal Reserve. Bernanke is just as responsible as Hu for undercutting foreign competitors as the U.S. dollar has depreciated relative to ALL global currencies besides the Yuan. Now we see the dollar rising as U.S. Treasury debt falls out of favor ahead of suspected Fed Funds hikes in 2010 and the Yuan will pop into higher territory right along with it. It would seem that world leaders should have called for a de-pegging from the dollar in December 2008 rather than the current level near rock bottom for the currency, but we digress.

We do see further dollar weakness as the initial Fed Funds Rate increases occur, should economic growth sputter. In this scenario there will be little upside potential for the U.S. dollar and the carry trade investments in U.S. assets will be far too risky, given the underlying weakness of American firms in such an environment. The potential for bond yields to rise and the dollar to fall a second time would be high in an environment where the U.S. government and private sector are both deemed poor refuges for individuals' cash. More immediately however, commodities will pull back as the rise of the dollar continues and the ability of gains to be made by U.S. investors amidst a rising dollar takes a great deal of money out of U.S. equities and into foreign stocks instead. We see this point as a good entry for short Oil positions and short U.S. equity positions.

Disclosure: Long SDS, Long SCC, Long DTO, Long TYO