Rebel Traders – Analysis Without The Hype

Harrisburg, the capital of Pennsylvania mulls Chapter 9 bankruptcy protection

The capital of Pennsylvania is debating if a chapter 9 bankruptcy filing is the right thing to do. The city is also looking at raising taxes and selling government assets. Harrisburg faces $68 million in debt payments due this year.

Every option, including tax and fee increases, bankruptcy and a state takeover through Pennsylvania’s Act 47 municipal oversight program will be considered, said Susan Brown-Wilson, chairwoman of the Budget and Finance Committee, which began a week of hearings last night to consider a 2010 spending plan.

The $68 million in debt service payments that Harrisburg faces in connection with the construction of a waste incinerator this year is four times what the city of 47,000 expects to raise through property taxes, and $4 million more than the city’s entire proposed operating budget.

“We need to see, what does Act 47 do for us; what does bankruptcy do,” Wilson said in an interview during a break in the opening budget hearing at Harrisburg City Hall. “You have to have all of them on the table.”

Harrisburg skipped more than $3.5 million in debt-service and swap payments last year, prompting draws on reserves and back-up payments by Dauphin County, where Harrisburg is located. The county has sued the city to recover its payments. […]

[…] “There’s never been a default like this in Pennsylvania municipal history,” she said. “This is all new territory.” […] (Bloomberg)

As I have talked about over the past many months, states and local governments will continue to be stressed and facing rising budget problems. There will be more stories like this one in the coming months.

One persons account of the recent World Economic Forum at Davos:

Many countries have started to see a rebound from last year’s economic recession. But will it last? Economists at the World Economic Forum in Davos warn that paying down massive public debt will be "very, very painful." Deep spending cuts and significant tax hikes may be unavoidable.

For those now in their 30s, Kenneth Rogoff has bad news. "It will be terrible for you," the Harvard University economics professor told a young German at the World Economic Forum in Davos. "Germany’s debt is exploding, the population is aging," he said. "And to be honest, I think your country is going to have average growth of just 1 percent in the coming years."

Rogoff went on to say that, should Germany wish to begin making inroads into its mountain of debt, there is no way around strict savings measures and significant tax increases. "It will be very, very painful," Rogoff said, adding that it will take at least a decade, and possibly many more, for Germany to pay down its debt.

He wasn’t the only one in Davos with a dark vision of the future. Many countries could be stricken with the "Japan illness," Robert Shiller, a behavioral economist at Yale University, told SPIEGEL ONLINE. Following a financial crisis in the 1980s, Japan’s economy remained in the doldrums for years as trust in the economy’s ability to recover evaporated. Few were willing to take risks, sapping the Japanese economy of its life blood, said Shiller. "Such a situation could take hold in many regions of the world."

Such prognoses raise questions about the recent global economic recovery, modest though it may be. Is a second recession just around the corner, part two of what some warn could be a "double dip?" In the fourth quarter of 2009, the US economy grew by an impressive 5.7 percent — but how durable are such gains?

One thing is clear: 2010 presents steep challenges to the world economy. "There is an illusion of normalcy," Rogoff warns. But that illusion, he points out, comes largely as a result of the immense amount of money pumped into the economy by governments around the world. The result — massive public debt across the globe — is "historically exceptional," Rogoff says. The only comparable situation can be found during the Great Depression, he points out. […] (Source: Spiegel Online)

National debt limit to be raised to $14.3 trillion. Today the Senate proposed allowing the federal government to borrow an additional $1.9 trillion to keep the lights on in Washington. The $1.9 trillion increase would be a new record.

The unpopular legislation is needed to allow the federal government to issue bonds to fund programs and prevent a first-time default on obligations. It promises to be a challenging debate for Democrats, who, as the party in power, hold the responsibility for passing the legislation. […]

[…] The measure came to the floor under rules requiring 60 votes to pass. That’s an unprecedented step that could mean that every Democrat, no matter how politically endangered, may have to vote for it next week before Brown takes office and Democrats lose their 60-vote majority.[…]

[…] A White House policy statement said the increase "is critically important to make sure that financing of federal government operations can continue without interruption and that the creditworthiness of the United States is not called into question." […] (AP)

The White House statement says it is critically important to safeguard the creditworthiness of the United States. What idiot in Washington came up with that press statement? If the United States wants to safeguard the creditworthiness they need to be reducing the debt, not increase it.

Everyday that passes I am even more amazed at just how stupid Washington thinks the American people are.

There are numerous reasons being floated in the media today to explain the sharp sell off in the equities market. Some are ridiculous, while others are meaningful. Unfortunately bubble TV pays little attention to the meaningful reasons, so let us briefly list the important ones here.

   Sovereign default concerns continue to grow for Greece and the Eastern European region.

   China has temporarily restricted banks from any further lending to control excesses in the economy. Additionally, a Chinese economist has floated the idea that China should curtail further purchases of U.S. debt.

   The U.S. dollar has risen significantly in response to the items listed above.

   Q4 earnings so far have been met with ‘sell the news’. An indication that stock prices have advanced far too much and earnings don’t substantiate the stock prices.

   Financial firms are still reporting en masse losses on loans and other credit portfolio products.

   The FHA, in an attempt to save itself from complete destruction has tightened lending criteria. A good first step for the FHA, but bad for those who were counting on more ‘easy money’ to keep the housing market afloat.

   Unemployment, unemployment, and unemployment.

   And the biggest one of all today is the Massachusetts senate election that elected Republican Scott Brown last evening.

Famed CNBC windbag Jim Cramer misinterpreted what the election of Scott Brown means. Jim Cramer claimed that the market would rally ‘huge’ today if Scott Brown were elected. The part that Mr. Cramer fails to comprehend is that Scott Brown threatens the normal way of life in Washington and he embraces the ‘tea party’ ideals of ending free money.

The ‘tea party’ movement has had lots of bad press. But that is understandable since the ‘tea party’ represents the idea of fair and balanced taxes, no bailouts for Wall Street firms who dug their own grave, and a government that actually represents the people instead of lobbyists and their interests. Any group of people that threatens the normal way of life in Washington will be singled out and made to look foolish by those who are threatened the most.

Senate elect Scott Brown says he will take to Washington the very concept that threatens the normal way of life, and that has Wall Street worried.

Illinois is technically insolvent…

Illinois appears to meet classic definitions of insolvency: Its liabilities far exceed its assets, and it’s not generating enough cash to pay its bills. Private companies in similar circumstances often shut down or file for bankruptcy protection.

"I would describe bankruptcy as the inability to pay one’s bills," says Jim Nowlan, senior fellow at the University of Illinois’ Institute of Government and Public Affairs. "We’re close to de facto bankruptcy, if not de jure bankruptcy." […]

[…] While Illinois doesn’t have the option of shutting its doors or shedding debts in a bankruptcy reorganization, it seems powerless to avert the practical equivalent. Despite a budget shortfall estimated to be as high as $5.7 billion, state officials haven’t shown the political will to either raise taxes or cut spending sufficiently to close the gap.

As a result, fiscal paralysis is spreading through state government. Unpaid bills to suppliers are piling up. State employees, even legislators, are forced to pay their medical bills upfront because some doctors are tired of waiting to be paid by the state. The University of Illinois, owed $400 million, recently instituted furloughs, and there are fears it may not make payroll in March if the shortfall continues.

Without quick corrective action or a sharp economic upturn, Illinois is headed toward a governmental collapse. At some point, unpaid vendors will stop bidding on state contracts, investors will refuse to buy Illinois bonds and state employees will get paid in scrip, as California did last year.

"The crisis will come when you see state institutions shutting down because they can’t pay their employees," says David Merriman, head of the economics department at the University of Illinois at Chicago.

A record $5.1 billion in state bills was past due at yearend, almost doubling to 92 days from 48 days a year earlier the average amount of time it takes the state to pay vendors such as doctors, hospitals, non-profit service providers and other contractors. (source: Chicago Business)

What happens when state budgets are broke? Only one of two things can happen, cut services and employees or raise taxes. Anyone care to guess which way Illinois will go?

In my own state of New Jersey, Governor Christie takes over the helm from Governor Corzine tomorrow. First order of business will be the budget. New Jersey has serious problems as well and expectations are for deep cuts across the board. But I won’t rule out tax hikes down the road either.

Stay tuned, the budget problems facing the states is just beginning.

This evening Moody’s has placed under review for downgrade hybrid and subordinated debt totaling $450 Billion of securities.

Moody’’s Investors Service has placed under review for possible downgrade the ratings of 775 hybrid and subordinated debt securities issued by 170 bank families in 36 countries following a change to its rating methodology for these instruments.

The reviews follow the rating agency’’s announcement that it has changed the way in which it rates these securities to take into account the fact that some recent government interventions in troubled banks have not helped, and have even been to the detriment of, the holders of these types of securities. For example, in some cases, support packages have been contingent upon a bank’’s suspension of coupon payments on these instruments as a means to preserve capital.

I say again.. We keep being told that everything is getting better. This only shows more (not less) deterioration is taking place within the financial markets.

As the G-20 tries to solve the issue of rolling back those trillions of dollars spent to keep banks afloat and to jump-start the economy, a Bloomberg article warns that of an impending new “Age of Austerity” might hit the world.

For this article, taxes will have to be raised and spending cut to hope facing the huge debt ahead. In a way not unlike Andy Xie, Pr. Kenneth Rogoff also warns that this could trigger the “double-dip” recession everybody fears so much. And for those who thought that the stimulus would predict high inflation and endless profits for the companies, they better revise their views: growth will be at best “dampened” according to Pr. Stiglitz.

Global leaders may be saddled with the weakest recovery since World War II if they are to pay off the $9 trillion tab they ran up rescuing the world economy from the deepest financial slump in seven decades.

(…)

“There’s no question that the most significant vulnerability as we emerge from recession is the soaring government debt,” said Harvard University Professor Kenneth Rogoff who is a co-author of a new history on financial crises. “It’s very likely that will trigger the next crisis as governments have been stretched so wide.”

Unwinding the borrowing will probably require leaders to raise taxes and cut spending, ushering in what HSBC Holdings Plc Chief Economist Stephen King calls an “age of austerity” that saps growth prospects for years to come even amid recovery.

The Organization for Economic Cooperation and Development predicts the world economy’s potential growth rate will fall to 1.1 percent next year, compared with 2.4 percent in the decade before the crisis. The International Monetary Fund says G-20 debt will reach 82.1 percent of gross domestic product in 2010, almost 20 percentage points more than two years ago and the equivalent of about $37 trillion.

‘Fiscal Mess’

“Economies have stabilized and now governments have to think more clearly about the fiscal mess,” said HSBC’s King, a former U.K. Treasury official.

Former Federal Reserve Chairman Alan Greenspan said Sept. 16 that U.S. debt, already about 84 percent of GDP, is “very dangerous” and threatens both Treasuries and the dollar.

Greenspan said that if there was a significant issuance of Treasury securities that increased the debt, “there would be of necessity downward pressure on the dollar.”

“We’ve got to confront that issue immediately,” he said.

(…)

Voter Anxiety

Voters are starting to signal discomfort with the global round of fiscal excess, adding to pressure on politicians. The budget deficit was listed as the third most-important issue facing the U.S. after the economy and health-care in a Bloomberg News poll this month and a majority of those surveyed criticized Obama’s handling of it.

In the U.K., Brown’s Labour Party received the support of just 26 percent of those polled by ICM this month, while backing for German Chancellor Angela Merkel’s Christian Democrats slid further in two surveys released yesterday before Sept. 27 elections.

Central bankers are sounding the alarm too in a sign they worry interest rates will have to be raised higher than they otherwise would be if governments don’t cut budgets.

“Everyone is concerned that we get back to a position where the public finances are clearly on a sound footing,” Bank of England Governor Mervyn King said Sept. 15.

Sovereign Debt

For now, bond investors are showing little concern about the debt as they focus on weak growth and indications from central banks that they’re not ready to start increasing interest rates. The Merrill Lynch & Co. Global Sovereign Broad Market Plus Index shows government debt yields this month reached the lowest since April.

AAA-rated countries, including the U.S., Britain, France and Germany, must articulate “credible exit strategies relatively soon” to shore up investors’ confidence, said David Riley, head of global sovereign ratings at Fitch Ratings in London.

Leaders say they are starting to plot how to withdraw the stimulus. Facing the biggest budget deficit in the G-20 at about 12 percent of GDP, Brown last week promised to make “hard choices” to cut U.K. costs. Goldman Sachs Group Inc. estimates U.S. fiscal policy will tighten by at least 1.6 percent of GDP in 2011.

The policy makers “need especially to speak about the U.S. deficit and the enormous amount of foreign capital that’s flowed into the U.S. to cover this deficit,” German Finance Minister Peer Steinbrueck told reporters in Berlin today before flying to Pittsburgh with Merkel.

Damping Growth

The crisis has permanently scarred the G-20’s economies by reducing their potential to grow, says James Nixon, co-chief European economist at Societe Generale SA in London. He estimates that the U.K. will have to raise taxes or cut spending to the tune of 9.1 percent of GDP to balance its books.

“This will depress growth for years to come,” said Nixon, a former economist at the European Central Bank.

Weaker long-term growth could compound the impact of a jump in interest rates should investor concern about deficits return. The Basel, Switzerland-based Bank for International Settlements said Sept. 13 that long-term bond yields will likely rise as investors refocus on the widening budget deficits.

“We could be in a pickle,” Nobel laureate Joseph Stiglitz, a professor at Columbia University in New York, said in an interview. “If long-term interest rates go up, that could be a damper.”

Of course, when you start a credit flood, this is to be expected… But yet, China is climbing into another American-style issue: defaults on credit card debt are rising by 131 %. Nice to see that the US have succeeded in exporting their irresponsible behavior to other countries.

Credit card debt in China at least six months overdue rose 131.3 percent year on year in the second quarter of 2009 to 5.77 billion yuan ($845.24 million), the People’s Bank of China, the central bank, said Wednesday.

Debts overdue by six months or more accounted for 3.1 percent of the total outstanding credit card debt at the end of June, or 0.7 of a percentage point more than in the same period last year.

The bank warned of potential risks of increasing overdue credit card debt as banks expanded the business.

By June 30, China’s banks had issued 162.62 million credit cards, or 0.12 per person, up 32.9 percent from a year earlier.

In the first quarter this year, credit card debt at least six months overdue rose 133.1 percent from a year earlier to 4.97 billion yuan.

As we are uncertainly heading on the path to recovery with again market exuberance to celebrate, the European Commission issued a preliminary report showing that the huge spendings on stimulus plans in the European Union (EU) these last few months evaporated a decades of fight for fiscal responsibility.

In a way, the legacy of the banking crisis is here to stay, even while the bankers did not change anything to their old habits: “stronger than expected” revenue shortfalls are causing an increase in the deficits of the European governments. At the same time, the bailouts and stimuluses are here to stay. And although we may rejoice today in seeing economic indicators turning green, the consequences of the huge debts being contracted by the States.

And Germany, one of the most fiscally responsible states in Europe is also taking the same route:

Germany sold $4 billion of bonds in its first dollar-denominated offering since 2005, according to a person familiar with the transaction. (…)

Europe’s biggest economy plans to sell 346 billion euros of debt this year, the most ever and almost half of this in bonds, according to data compiled by Bloomberg. Selling debt in dollars rather than euros may allow Germany to appeal to a wider range of investors, including money managers in the U.S. that don’t want to take on foreign-exchange risk. (…)

Germany’s sale follows syndicated dollar bond issues from Spain and Belgium last week, which raised a total $3.5 billion, according to Bloomberg data. Governments around Europe have hired banks to lead bond issues this year to help them raise more money to pay for fiscal stimulus programs amid the deepest recession since the 1930s.

So, we may come out of a recession by 2010… But then we also have a lot of elements pointing to adverse conditions for the economy.

Publication 15864 En

We pointed out a previous economic analysis by Andy Xie on the subject of a crash predicted for 2010 by the Chinese economist… Back in June 2009.

However, as economy is a living human science, economists are bound to adapt their analysis with the evolution of the economy.  However, Andy Xie confirms his outlook of a second dip by 2010, taking into account the new bubble created by the assets.

Short-term however, Andy Xie points out that the markets should do well for the coming two months. He also reaffirms his belief in an inflationary scenario, which, for me, is somewhat questionable. True enough, expectations and market games can push assets prices upwards (the “self-realizing” prediction to which Andy Xie is affectionate). But in the end, the realization that the economy is moving slower than expected should just kill that inflationary play, lowering assets prices and at that point the question would be whether the dip in assets prices would kill the economy or give it the oxygen it needs to continue recovering.

Needless to say, Andy Xie finds that a keynesian policy will not work in the US, for the simple reason that the US consumers have been shocked into saving. Recreating another bubble seems the policy being effected right now and whereas it will be effective for a while, it may (and probably will) backfire on the long run. In short, a worthwhile analysis to read by anyone who has the desire to go look behind the media coverage and look at the workings of the economy. Also, it brings some much needed discussion of Keynesian theses vs the governments’ policies.

In a normal economic cycle, an inventory-led recovery would be followed by corporate capital expenditure, leading to employment expansion. Rising employment leads to consumption growth, which expands profitability and more capex. Why won’t it work this time? The reason, as I have argued before, is that a big bubble distorted the global economic structure. Re-matching supply and demand will take a long time.

The process is called Schumpeterian creative destruction. Keynesian thinking ignores structural imbalance and focuses only on aggregate demand. In normal situations, Keynesian thinking is fine. However, when a recession is caused by the bursting of a big bubble, Keynesian thinking no longer works.

Many policymakers actually don’t think along the line of Keynes versus Schumpeter. They think in terms of creating another bubble to fight the recessionary impact of a bubble burst. This type of thinking is especially popular in China and on Wall Street. Central banks around the world, although they haven’t done so deliberately, have created another liquidity bubble. It manifested itself first in surging commodity prices, next in stock markets, and lately in some property markets. Will this strategy succeed? I don’t think so.

The lifespan of a bubble depends on how it affects demand. The longest-lasting are property and technology bubbles. The multiplier effect of a property bubble is multifaceted, stimulating investment and consumption in the short term. The supply chain it impacts is very long. From commodity producers to real estate agents, it could stimulate more than one-fifth of an economy on the supply side. On the demand side, it stimulates credit growth and financial sector earnings, and often boosts consumption through the wealth effect. Because a property bubble is so powerful, the negative effects of a bursting are great. Excess supply created during a bubble’s lifespan takes time to consume. And a bust destroys the credit system.

(…)

A pure bubble tied to excess liquidity that affects one or many financial assets cannot last long. Its multiplier effect on the broad economy is limited. It could have a limited impact on consumption due to the wealth effect. As it neither stimulates the supply side nor boosts productivity, whatever story it is based on will have holes that become apparent to speculators. It doesn’t take long for them to flee. Furthermore, a pure liquidity bubble without support from productivity can easily lead to inflation, which causes tightening expectations that trigger a bubble’s burst.

What we are seeing now in the global economy is a pure liquidity bubble. It’s been manifested in several asset classes. The most prominent are commodities, stocks and government bonds. The story that supports this bubble is that fiscal stimulus would lead to quick economic recovery, and the output gap could keep inflation down. Hence, central banks can keep interest rates low for a couple more years. And following this story line, investors can look forward to strong corporate earnings and low interest rates at the same time, a sort of a goldilocks scenario for the stock market.

What occurred in China in the second quarter and started happening in the United States in the third quarter seems to lend support to this view. I think the market is being misled. The driving forces for the current bounce are inventory cycle and government stimulus. The follow-through from corporate capex and consumption are severely constrained by structural challenges. These challenges have origins in the bubble that led to a misallocation of resources. After the bubble burst, a mismatch of supply and demand limited the effectiveness of either stimulus or a bubble in creating demand.

(…)

Recent data point to a sharp increase in the household savings rate in the United States. Over two years, it rose above 5 percent from minus 2 percent. The current level is still below the historical average 8 percent. If normalization remains on track, it should rise above 8 percent, and probably reach above 10 percent, to bring debt levels down to the historical average.

Some argue that, if low interest rates revive the property market, American households may be willing to borrow and spend again. This scenario is possible but not likely. The United States has not experienced serious property bubbles in the past because land is privately owned and plentiful. A supply overhang from one bubble takes a long time to digest. And American culture tends to swing to frugality after a bubble. One’s outlook either for a normal recovery or a bubble-inspired boom depends on the outlook for the U.S. household savings rate. Unless the U.S. household sector is willing to borrow and spend again, emerging economies will not be able to revive the export-led growth model.

If one accepts that the U.S. household savings rate will continue to rise, emerging economies must decrease their savings rates, increase investment, or decrease production. The best choice is to decrease savings rates. But savings rates are hard to change. They depend mainly on demographics and wealth levels. The quickest possible way out would involve creating an asset bubble that inflates household wealth and decreases savings. Many advocates of inflated property and stock markets in China have this effect in mind. Japan’s bubble after the Plaza Accord in 1985 had its origin in the same dilemma. This approach, if it works, has catastrophic long-term consequences. Japan remains mired in stagnation two decades after its bubble began to burst.

(..)

Conventional wisdom says inflation will not occur in a weak economy: The capacity utilization rate is low in a weak economy and, hence, businesses cannot raise prices. This one-dimensional thinking does not apply when there are structural imbalances. Bottlenecks could first appear in a few areas. Excess liquidity tends to flow toward shortages, and prices in those target areas could surge, raising inflation expectations and triggering general inflation. Another possibility is that expectations alone would be sufficient to bring about general inflation.

Oil is the most likely commodity to lead an inflationary trend. Its price has doubled from a March low, despite declining demand. The driving force behind higher oil prices is liquidity. Financial markets are so developed now that retail investors can respond to inflation fears by buying exchange traded funds individually or in baskets of commodities.

Oil is uniquely suited as an inflation hedging device. Its supply response is very low. More than 80 percent of global oil reserves are held by sovereign governments that don’t respond to rising prices by producing more. Indeed, once their budgetary needs are met, high prices may decrease their desire to increase production. Neither does demand fall quickly against rising prices. Oil is essential for routine economic activities, and its reduced consumption has a large multiplier effect. As its price sensitivities are low on demand and supply sides, it is uniquely suited to absorb excess liquidity and reflect inflation expectations ahead of other commodities.

If central banks continue refusing to raise interest rates during these weak economic times, oil prices may double from their current levels. So I think central banks, especially the Fed, will begin raising interest rates early next year or even late this year. I don’t think it would raise rates willingly but wants to cool inflation expectations by showing an interest in inflation. Hence, the Fed will raise interest rates slowly, deliberately behind the curve. As a consequence, inflation could rise faster than interest rates, which is what the indebted U.S. household sector needs.

This fool-the-market strategy may work temporarily. Its effectiveness must be reflected in oil prices; the Fed needs to target oil prices in its interest rate policy. If oil prices run from current levels, it means the market doesn’t believe the Fed. That would force the Fed to raise interest rates quickly which, unfortunately, would trigger another deep recession.

Instead of a V-shaped recovery, we may instead get a W curve. A dip next year, although perhaps not statistically deep, could deliver a profound psychological shock. Financial markets are buoyant now because they believe in the government. The second dip would demonstrate the limits of government power. The second dip could send asset prices down — and keep them down for a long time.

Remember, this is a credit/debt recession. Notice the last time we had debt that went out of control… 1929

Debt To GDP Chart