Monday, December 28, 2009

Sprott: Is It All Just A Ponzi Scheme?

Well respected investor Eric Sprott's recent client newsletter opines that the Federal Reserve system might just be one big ponzi scheme...

The problem is that nobody knows who is buying a huge chunk of US Treasuries - which are categorized under "Other Investors".

This is a must read and a reason why at a minimum the Fed needs to be audited.

Scott Dauenhauer CFP, MSFP, AIF

Goldman Profits Twice on Mortgage Sales

Here are the basics:

Goldman creates a mortgage back security or CDO and sells it to you - knowing that it is a worthless piece of junk because they had to convince (and probably pay off) their friends at the rating agency in order to get it a decent rating. Goldman knows its junk and just a matter of time before this junk explodes - thus they help create securities that allow them to profit when this junk does explode (or choose).

So Goldman makes money selling junk, then makes leveraged bets to short the junk it just sold you and makes a mint when the junk goes bad......does this sound like a healthy financial system?

Scott Dauenhauer CFP, MSFP, AIF

Sunday, December 27, 2009

"All of this has happened before, and it will all happen again."

Do you recognize this line? If so you may be a fellow "Battlestar Galactica" fan. I won't give away any secrets of the hit series but the oft used phrase feels applicable to the financial crisis that engulfed the world last year and is perhaps awaiting its second (or perhaps third) movement.

The parallels to our financial system with the themes of Battlestar Galactica are frightening, a constant evolution of finance that eventually destroys itself and then rebuilds just to destroy itself again....can the cycle be broken?

Last year the parody website and newspaper, The Onion posted a parody piece titled "Recession-Plagued Nation Demands New Bubble To Invest In" (link above). While all good humor requires some truth, this piece is actually prophetic. Our Federal Reserve system has set us on a cycle that won't be broken unless someone stands up and says "enough". The fix is not easy (which is why we haven't fixed our problems, we've covered them up) and will hurt, but severe pain that is short-term is preferable to pain that is chronic and never ending.

All of this has happened before, it will happen again.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, December 17, 2009

Bi-Partisan Agreement on Taxpayer Funded Foreign Travel

If this story requires a log-in, I can e-mail you a new link that will work.

At least Democrats and Republicans can agree on one thing, the taxpayers shouldn't fund travel and shindigs for private companies.....but they should fund them for congress. The above linked article goes into some detail about recent trips take by both parties to lush locals (with spouses and on military jets). The costs for these trips have skyrocketed in recent years. While some trips appear legit, others are clearly taxpayer funded pleasure trips disguised as official business.

Do we really need more proof that our spending is out of control? It's not healthcare that is going to bankrupt this nation, its a profligate congress.

Scott Dauenhauer CFP, MSFP, AIF

Friday, December 11, 2009

Ben's Bastardization of Bagehot

"[T]o avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at 'high rates.'"

These are the words of Walter Bagehot, a Brit famous for his work and writings about economics and specifically about "Lenders of last resort" or Central Banks.

Bagehot has five basic dictums to avert a panic:

Lend Early
Lend Freely (without limit)
Lend to Solvent Firms
Lend against Good Collateral
Lend at High Rates

Bagehot is often referred to by central bankers when bailing out financial institutions and he has been quoted by Bernanke in the past, it is clear that Bernanke (Federal Reserve Chairman) has been influenced by Bagehot.

The question really becomes, is Ben Bernanke following the Bagehot dictums or bastardizing them?

I vote for the latter, though my vote doesn't matter, the evidence is clear the latter is the course taken.

Did the Fed lend early?

No, in fact it didn't understand the true nature of what was happening on Wall Street (though keep in mind the Fed was set up to work with banks, not necessarily investment banks - but that line was crossed when Glass-Steagall was repealed and the Fed should have been prepared)

Did the Fed Lend Freely?

Not really, not until it was too late (they helped Bear, but not Lehman). This one they get a free pass as they should not have lent to Bear or Lehman give the next few dictums

Lend to Solvent Firms?

Now this is the funny thing, it seems the Federal Reserve and Treasury are doing the exact opposite of the Bagehot Dictums, they are lending the most to the most insolvent firms (Citi, Bear, AIG, Fannie, Freddie). This is the key to all the other dictums, my belief is that Bagehot felt that insolvent firms should be allowed to fail, allowing them to continue created moral hazard and rewarded the profligate at the expense of the parsimonious (a bit strong, but both P words!). The big mistake made was the free lending of funds to firms that are now and will be in the future insolvent.

Lend against Good Collateral?

I think the evidence shows that the collateral lent against was not good, in fact our own government called it Toxic.

Lend at high rates?

There is some disagreement about why Bagehot created this dictum - was it to avoid moral hazard or to simply keep the solvent, liquid firms from borrowing needlessly. Regardless, it works both ways and avoids moral hazard while keeping solvent firms with cash away from borrowing. The Fed and Treasury fail on this point. Warren Buffet lent at much better terms to Goldman Sachs than did the Treasury. Banks can now borrow from the Fed at effectively a zero percent rate - which they do and then engage in a carry trade.

Ben Bernanke's Fed and Paulson/Geithner's Treasury have used Bagehot's dictums as an excuse for their bailout's, but in doing so have bastardized them.

Effectively the Fed's action have turned what would have been a Great Recession into a Depression and potentially into another Great Depression, far from avoiding a Depression, Bernanke, Geithner and Paulson have served one up for us.

Don't mistake me to be saying that the markets are going to crash, though that possibility exists. My point is that while a recovery could be underway and may in fact happen (perhaps even greater than we all think), it will in fact be another in a long series of faux rallies, perhaps the third in a trilogy that began with the Tech bubble and crash, then continued with the Housing bubble and crash. What will this third (and hopefully last) bubble bring? When will it end? What will be its affects? These are all questions without good answers (though many are trying).

It feels ironic to me that Paul Volcker is once again the voice of reason and sanity and yet he seems to be ignored in favor of Bernanke, Geithner, Dodd and Frank. Will it be the irony of ironies that the window dressing (Volcker) is in fact the one person in this administration that people should be listening too? I'm not saying we should rename Volcker to the Fed, but certainly getting rid of Geithner and replacing Bernanke would be wise moves.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, December 10, 2009

WAPO: Mortgage agency's growth gives fuel to risky lenders

Unbelievable. That is the only word to describe this article about how poorly Ginnie Mae has been run. The corruption that is taking place in broad daylight in front of these people is scary and yet it is allowed to continue in order to reflate housing. I hope this story brings about the change needed, otherwise we the taxpayer are going to be shelling out in more ways than one.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, December 09, 2009

Humor Break: Colbert Takes On The Fed

If you don't fall out of your seat laughing after this......well, you're probably not a finance geek like myself - but this if funny stuff!

The Colbert ReportMon - Thurs 11:30pm / 10:30c
Fed's Dead
Colbert Report Full EpisodesPolitical HumorU.S. Speedskating

Monday, December 07, 2009

On Federal Reserve Independence

It is no secret that Thomas Jefferson was against a central bank, in fact the following quote seems rather prophetic:

The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.

The debate today however is not a Jefferson versus Hamilton (should we or shouldn't we have a central bank), but whether or not the Federal Reserve should be Independent of the federal government. There is much debate about the independence of the Federal Reserve, many don't believe it is Independent, or do and want it more accountable. The fact of the matter is that the Federal Reserve is a branch of government, though it is controlled by bankers and is perhaps the most powerful branch of our behemoth government.

In David Wessel's book, "In Fed We Trust" there are a few things that I learned that shocked me, but now make sense given what has transpired over the past few years:

"From the beginning, the regional Fed banks were organized not as government agencies, but as private companies in which local banks own shares, a remnant of a time when central banks raised capital privately as well as publicly. Under the 1913 law (to create the Fed), each bank has nine directors, the majority chosen by the banks in the district. Three are bankers. Three are nonbankers picked by the local banks. Three are chosen by the Fed board in Washington to represent the public."

Interestingly enough the "nonbanker" chosen for the New York Federal Reserve was none other than Stephen Friedman, a former Goldman Sachs CEO and then member of the Goldman board of directors (now disgraced and no longer a member of the NY Fed after it was discovered he was buying stock in Goldman Sachs while he was making decisions about its future).

It was these people who hire the head of the New York Federal Reserve branch (the most powerful branch), it was these people (the so-called bankers and non-bankers....who were really just insiders and bankers) that hired Timothy Geithner. Its a pretty nice deal when you can essentially hire your own regulator.

Its beginning to make sense why the Federal Reserve was so asleep at the switch, they were never supposed to be awake, it was set up that way (maybe not originally, but that is how it turned out).

In Wessel's book he makes clear that Bernanke and even Geithner did not understand the complex securities being traded and sold by wall street and the banks - which is a complete dereliction of duty, which should be punishable by job loss. Instead Geithner and Bernanke kept their jobs and Geithner was promoted (this must be one of the jobs "saved").

My point is that the Federal Reserve is NOT independent, it is highly controlled and it is designed to work in favor of Wall Street and the bankers, not main street and the citizens. Whether or not the Federal Reserve is independent of congress and the President is a moot point, they are not independent of those who control congress and the President.

Fed Independence is a myth and the current debate is a waste of time, the real question is not how much power the congress should have over the Fed, the real question is how much control Wall Street should have over the citizens of the United States.

Scott Dauenhauer CFP, MSFP, AIF

Friday, December 04, 2009

Confronting the Inflation Boogeyman

Hearing a lot about Gold lately? Comparison of America to Zimbabwe? Is America a Banana Republic? Hyperinflation has become the buzzword, but is it real and is it a possibility?

The answer is not easy, evidence suggests we are not heading toward hyperinflation, defined as a 50% inflation....per month! However, given the events of the past decade one cannot rule anything out.

I wouldn't bet on a hyperinflation, but I do believe inflation will be an issue in the intermediate to longer term.

Don't discount the possibility of a short-term recovery fueled by speculation, low interest rates, massive government spending and misplaced euphoria (sound familiar?). While 2010 could bring with it the complete disintegration of the banking system, it could also bring the sense of relief, that prosperity is back and things are okay again. Don't be lulled, be on the defensive - but part of the point of the linked too article is to be careful of going overboard in your defense.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, December 03, 2009

Prins: Enron Accounting for US Banks

Nomi Prins writes about what I've been saying now for months, big banks are rigging their books....Enron style. A few snipets from this former Goldman Sachs Managing Director:

After two weeks sifting through over one thousand pages of SEC filings for the largest banks, I have the same concerns. While Washington ponders what to do, or not do, about reforming Wall Street, the nation’s biggest banks, plumped up on government capital and risk-infused trading profits, have been moving stuff around their balance sheets like a multi-billion dollar musical chairs game.

I was trying to answer the simple question that you'd think regulators should want to know: how much of each bank’s revenue is derived from trading (taking risk) vs. other businesses? And how can you compare it across the industry—so you can contain all that systemic risk? Only, there's no uniformity across books. And, given the complexity of these mega-merged firms, those questions aren’t easy to answer.

With taxpayers now on the hook, we need an objective, consistent evaluation of bank balance sheets complete with probing questions about trading and speculative revenues, allowing for comparisons across the banking industry. This lack of transparency leaves room to misrepresent risk and trading revenue.

The long-term solution is bringing back Glass-Steagall. Being big doesn’t just risk bringing down a financial system—it means you can also more easily hide things. Remember the lesson from the Enron saga: when things look too good to be true, they usually are.

Nomi Prins is author of It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley, September, 2009). Before becoming a journalist, she worked on Wall Street as a managing director at Goldman Sachs, and running the international analytics group at Bear Stearns in London.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, December 02, 2009

Ferguson: An Empire at Risk

Rising interest rates and deflation? This is a scenario Nial Ferguson has put forth in this Newsweek article that explores the consequences of a rising national deficit. The article is long, but good.

Scott Dauenhauer CFP, MSFP, AIF

Farrell: Obama's 'predictably irrational' economic policies

14 reasons Obama's love of Wall Street will trigger the Great Depression 2

This is not the column I expected to see from Paul Farrell, it is based on a newsletter I posted last month by GMO's Jeremy Grantham and it is spot on.

The reiteration by Farrell that Geithner and Bernanke should lose their jobs is perhaps the best points, though their are many others. Lest you think this article is an Obama tirade by an angry right is not, Farrell supported Obama and he lambast's the Bush administration's handling of the crisis as well.

Scott Dauenhauer CFP, MSFP, AIF

Monday, November 30, 2009

Mauldin: Why I Am An Optimist

Okay, so I've been a bit negative on things....I get it, the truth hurts. But what sometimes gets lost in the shuffle is that while I'm pessimistic about certain things, at heart I'm an eternal optimist.

A few months ago I was having lunch with a friend and we were talking about energy and cars and solar panels....and the future. My thought was that all of these things were on the verge of technological leaps in ways that none of us could imagine. I was thinking about this conversation when I read John Mauldin's latest piece, I think you'll enjoy it.

Scott Dauenhauer CFP, MSFP, AIF

Leon Jones, CFP - Rest in Peace

I just learned of Leon's death; since I moved out of Orange County we had only kept in touch at conferences, I was saddened to hear of his passing. Leon was one of the good guys, someone you could trust. He was a credit to this profession and I will miss him. We served on the board together of the Orange County FPA chapter. You will be missed friend.


Jones, Jr., Leon, age 57, of Laguna Niguel, passed away Sunday November 8, 2009 at Western Medical Center in Santa Ana. Leon was born to Leon and JoAnne Jones on June 18, 1952 in Virginia. He proudly served as Director for the Lipton Tea Company, Vice President of Calvo, after which, he became self employed as a Financial Advisor. Leon is survived by his beloved wife, Andrea Jones; his son, Kevin Jones and his daughter, Megan Jones, each of Laguna Niguel; his mother, JoAnne Jones and his sister, Sherry Guthrie of Virginia. Arrangements are being handled by Miller Jones Mortuary & Crematory. Funeral Services will be held on Friday, November 13, 2009 at 3:30 p.m. at Coast Hills Community Church located at 5 Pursuit, Aliso Viejo, CA. Leon touched many lives and will truly be missed by all who knew him and loved him. We have started a Leon Jones Memorial Fund at USC/Norris Cancer Hospital if you wish, you may contribute. Miller-Jones Mortuary

Sunday, November 29, 2009

Arnot: What Can't, Won't Be

Rob Arnott (manager of PIMCO All Asset and All Asset Authority) publishes his quarterly commentary, its worth looking at. The debt figures alone are scary.

Scott Dauenhauer CFP, MSFP, AIF

Friday, November 20, 2009

Margin of Safety - Does It Exist?

Benjamin Graham made famous the concept of "Margin of Safety" which basically refers to the price at which an investment will trade that yields minimal downside risk (or acceptable).

At today's stock market valuations there does not appear to be a reasonable "margin of safety". What external market events could cause valuations to contract, perhaps in a severe manner, I've thought of just a few possibilities:

Oil Shock - oil at $200 per barrel (not predicting, but it is now within the realm of possibility through either a falling dollar or a nuclear explosion in Saudi Arabia)

Pandemic - The H1N1 has proven to be more bark than bite (or is that squeel?), but what if it mutates like what happened to cause the Spanish Flu?

Massive California Earthquake (that couldn't happen, forget I even mentioned it)

Bad hurricane season

A major country defaults on its debt, which is widely held (oh wait.....did somebody say Ukraine)

Massive Terrorist attack (or even a small one that strikes the right cord)

Residential and Commercial Real Estate Crash - not the last one, the next one

Global War

Magnetic Pulse bomb

Ben Bernanke re-appointed to the Fed (oh wait.....that already happened!)

Tim Geithner appointed Treasury Secretary (oops.....that happened as well)

Major investment bank reveals massive trading losses due to over-leveraged bets against the dollar or some other asset (this couldn't happen since our banking leaders are at the frontier of managing risk exposure...that was a joke by the way)



Okay, you get the picture. If stocks were trading at 8 or 10 times trailing P/E's perhaps all of the above risks would be worth assuming, however with them trading at 20 times trailing P/E's there does not exist much margin for failure.

The question you have to ask yourself is "Do you feel lucky, Punk?"

Scott Dauenhauer CFP, MSFP, AIF

Meridian Commentary: Monopoly Money

Monopoly, the still popular empire building game was introduced to America during the Great Depression, 1935 - it was an instant hit. Monopoly is my favorite board game, I'd rather play it than poker or video games (though fewer share my passion and thus I rarely get to play - though I can now play it on my iPhone.....not the same). Why bring this up today? I bring it up because the U.S. is beginning to look and sound like a Monopoly board. Not in the since that we are a nation of monopolies - though replacing Boardwalk and Park Place with the Federal Reserve and Wall Street Banks might feel appropriate, but because two of the more popular "properties" the utilities and the railroads are suddenly popular again. I always go for the railroads...consistent income and each additional one you own multiplies the rents.

Warren Buffett just spent a fortune buying....a railroad. In the age of technology and nearly 75 years after railroads appeared on the monopoly game board.....we're still buying them. Then famed Bond Guru Bill Gross yesterday comes out with the notion that one should be buying Utilities. Two investment legends buying old school railroads and utilities during a time that can only be marked by the term Depression. Now, I can't exactly relate the rest of the board game to today's realities - Real Estate is in terrible shape and building homes and hotels seems like a loser's game. What today really feels like in terms of Monopoly is the "hunker down" method of playing - you know, when you are nearly out of cash, but have lots of property (but all different colors and they are all overleveraged) and you realize that one false step (bad roll of the dice) will force you into bankruptcy? Your only play is hope that your roll of the dice gets you to a safe no or low-rent property or jail, God forbid you roll doubles. The hunker down mentality is also that of the Federal Reserve and its member banks (which is ironic considering they can print money and essentially they are the banker). They are just hoping to pass GO enough times to build up their balance sheet (the banks balance sheets) and cash for when the next roll of the dice yields a free pass to Boardwalk...which they just lost to a hedge fund that has now fully leveraged it and is charging outrageous close to passing Go, unfortunately it becomes the last roll as Boardwalk bankrupts - not even China (another player at the table) can bail them out (of course they try).

When will the US hit its Boardwalk moment? Can we Pass Go enough times to rebuild our balance sheets? Should we be buying railroads and utilities? Not since the debut of Monopoly have so many people hoped for a "Chance" card that will either given them the jackpot or send them to jail (where they are relieved of rolling for a bit).

My point...I really just thought it was interesting that two famed investors were buying railroads and utilities, but the more I think about it the more I hope we can get out of this Monopoly game (ironic that the dollar is now being talked about as "monopoly money") and play a game that is based in reality, perhaps the game of Life!

Scott Dauenhauer CFP, MSFP, AIF

Thursday, November 19, 2009

Arnott: CPI is a "massive shell game"

Mr. Arnott said, when the Bureau of Labor Statistics used car prices that were net of the “cars for clunkers” program. That program gave qualifying automobile buyers up to $4,500 in rebates, which the BLS calculated as a price drop.

“That’s pure fraud” in the CPI, Mr. Arnott said, adding that low inflation figures also tend to overstate real GDP growth.

Who pays Federal taxes (and coming Middle class tax increase) has created a wonderful graphic demonstrating who pays what percentage of the Federal income tax.

There are a few takeaways, the first is 47% of the taxable units pay ZERO taxes and the top 1% of income earners pays 40% of our taxes, the top 10% of income earners pay over 70%.

Why is this important? You can only raise taxes on the "rich" so much, there are far too many people in the middle class and a small increase on them equals a huge amount of taxes. Taxes on the middle class are going to go up.

Scott Dauenhauer CFP, MSFP, AIF

China's 14 Dominoes of Destruction

As I understand it China is the rising superpower and will one day rule the world, while that scenario may in fact play itself out, perhaps it will happen differently than people believe (at least today). The dominant trend is that China is the place to be, they are the future.

There is only one problem with such a belief, it rests solely on the belief that communism was simply misapplied in the past, that China has perfected it and the master central planners who repress their citizens (among other things) will finally create the utopia that is the dream of communism.

Communism has never and will never work, not even the so-called "hybrid version" that attempts to fuse some form of capitalism into it. The distortions can only go on for so long, the tastes of freedom and prosperity will only continue to push the Chinese people to destroy their current government.

I'm not saying China will fall this year or next or even within the decade, but as with all Communist Repressive regimes in the past, this too will fail - what takes its place will be the true event of this century.

Wednesday, November 18, 2009

Whitney Fears Stocks

Meridith Whitney called last year's crash...she's back, will the magic work a second time - she's not bullish.

Scott Dauenhauer

SOW: Brokers' Favorites? Funds That Pay Well

Secrets of the Wirehouse:

Surprise, Surprise - turns out that brokers like to sell mutual fund products that pay them more compensation...and these funds tend not to be any better than funds a person could pick randomly on their own.

Perhaps it’s worth it for more investors to read up on mutual funds and pick their own. The first of the two studies mentioned above found that fund buyers who avoid brokers tend to be a little richer and a little better educated than those who don’t, but not much. In other words, many fund buyers who pay brokers can probably do it themselves.

Scott Dauenhauer CFP, MSFP, AIF

Friday, November 13, 2009

SOW: MSSB To Pay 330% Upfront Bonus To Attract Brokers

SOW = Secrets of the Wirehouse.

Morgan Stanley Smith Barney is looking to beef up the number of financial advisors (brokers) they employ. They are offering brokers at other firms up to 330% of their trailing twelve month's commissions as an inducement to leave and come to MSSB.

Does this sound like its in the best interest of the clients? Let's say the broker had $500,000 in sales last year - he/she might be offered $1.65 million to move to MSSB and bring their clients with them. Just who is this broker now beholden too? Do you think they might have to tow the party line after such a big bonus? Is this in the best interest of their clients? Of course not, no fiduciary in their right mind would offer such a package and no fiduciary in their right mind would accept.

Its one thing to offer money in a merger of equals to help offset merger costs, its another when you offer an outright bribe.

This is just another in a long string of things brokerage firms (wirehouses) do that are not in their clients best interest. By the way, who do you think will bail out Morgan Stanley when they get to leveraged and blow guessed right, the taxpayer.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, November 10, 2009

ShadowStats: Unemployment Really at 22%

From a New York Post article on unemployment numbers:

"Starting in the Clinton administration, Americans who told Census Bureau investigators, over a period of a year, that they were too discouraged to even look for a job simply vanished from U-6.

And considering how prolonged today's periods of unemployment can be, there are probably more people simply falling out of the count, although the Labor Department has no idea how many for certain.

My friend John Williams of Shadow Government Stats thinks the true unemployment rate would be 22.1 percent if everyone -- all discouraged former workers, encouraged, involuntary part-timers and the like -- were included.

Here are more numbers to fry your brain and cause a temporary sense of helplessness.

The government's household survey (the one from which the unemployment rate of 10.2 percent comes) showed a "decline in employment" of 589,000 in October, which followed a 785,000 employment drop in September.
That number also includes people who say they retired and others who were fortunate enough to have died during the past month and no longer require a job.

More numbers: Last Friday's 190,000 loss of jobs (from the survey of companies) would have been worse if 86,000 imaginary jobs weren't included to the tally."

Monday, November 09, 2009

Idiocranomics: First Time Homebuyer Credit Extended and Expanded

Not content with creating one housing bubble, our congressmen and women are doing their best (along with the Fed) to create another, passing an extension and expansion of the First Time Homebuyers Credit. This is bad policy and will only make things worse in the end. While it may seem like a gift to those who are buying homes now, it is part of a broader bank bailout and will only prop up housing temporarily. Of course the the massive fraud that has been perpetrated by those taking the tax credit who are ineligible didn't stop Democrats and Republicans from doing what is right by the American people - which would have been to end the credit.

Scott Dauenhauer CFP, MSFP, AIF

Chanos: Ten Lessons From the Financial Crisis That Investors Will Soon Forget (If They Haven't Already!)

22304084 Chanos Presentation

Idiocranomics: Tax Credit Sales (thankfully blocked)

So last week the news came out that Fannie Mae was planning on offloading some "Tax Credits," effectively selling them for 50% on the dollar to Goldman Sachs and Warren Buffet's Berkshire Hathaway. Fannie Mae has no profits and never will, thus the credits are useless to them, why not sell them? The problem is that those credits would be bought for half their value and then used to offset actual taxes owed of their actual value - meaning the sale would lose the Treasury $3 billion. Normally I'm a big fan of lowering taxes, but this didn't seem right - for two reasons:

Reason #1: Why can corporations trade tax credits and individuals cannot? I cannot purchase non-refundable tax-credits from people who could not utilize them, yet corporations can?

Reason #2: We the taxpayers are subsidizing Goldman and bailed Goldman out last year, they would not be here today without us little guys. Now they are paying record bonuses on revenue generated on our backs. They should not be given the opportunity to lower their taxes by buying tax credits at a discount - it is morally unethical in this scenario. As for Warren Buffett.....just imagine the outcry if Halliburton had did the same thing under the Bush administration - the outrage would be epic. Buffet is an insider in the Obama administration and for that reason there cannot be an arms length agreement, he should not be allowed to buy the credits, Buffet should know better.

For once I will praise Tim Geithner (don't get use to it Tim, you are the king of Idiocranomics and I'm sure this decision was made in order to make your week easy, not because it was the right thing to do).

Scott Dauenhauer CFP, MSFP, AIF

Einhorn: Time to Ban Credit Default Swaps

The linked to article is short and gives a great explanation of CDS (Credit Default Swaps) and why they should be banned. I support Einhorn on this, these "financial weapons of mass destruction" are a cancer on our system.


“I think that trying to make safer credit default swaps is like trying to make safer asbestos,” he writes in a recent letter to investors, adding that CDSs create “large, correlated and asymmetrical risks” having “scared the authorities into spending hundreds of billions of taxpayer money to prevent speculators who made bad bets from having to pay”.

Financial Times and Einhorn explanation of CDS:

CDSs are “anti-social”, he goes on, because those who buy credit insurance often have an incentive to see companies fail. Rather than merely hedging their risks, they are actively hoping to profit from the demise of a target company. This strategy became prevalent in recent years and remains so, as holders of these so-called “basis packages” buy both the debt itself and protection on that debt through CDSs, meaning they receive compensation if the company defaults or restructures. These investors “have an incentive to use their position as bondholders to force bankruptcy, triggering payments on their CDS rather than negotiate out of court restructurings or covenant amendments with their creditors”, Mr Einhorn says.

We have serious issues in our financial system, this is one step we can take to remove the insane amount of leverage currently in our system.

Scott Dauenhauer CFP, MSFP, AIF

WSJ: The Man Who Predicted the Depression

A great piece about an economist that is rarely mentioned by the "well known" economists of today.....probably because they ignored his work, at their peril.

"Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today."

Mises predicted the Great Depression and his work would have led economists to predict today's depression, yet I can tell you that in all my years of studying economics in school - Mises name never came up. Instead all we heard about was Keynes, a man who lost a bunch of money in the great stock market crash of 1929 and then was made famous because his work seemed to indicate that you could get out of a depression via government spending (which FDR used as his basis for increased government intervention). However, Mises had the right prescription:

"Mises's solution follows logically from his warnings. You can't fix what's broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don't encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts. (You see where I'm going with this.) The distortions must be removed or else the precipice from which the system will inevitably fall will simply grow higher and higher."

We have again chosen to side with Keynes, a decision that landed our nation in a perpetual depression under FDR and the reason the unemployment rate today is 17.5% (BLS U-6) and 22% if we use measurements.

We are indeed on a dangerous path.

Scott Dauenhauer CFP, MSFP, AIF

Friday, November 06, 2009

Petition: Too Big Too Fail is Too Big Too Exist

Please click on the headline and sign this important petition

Petition to Treasury Secretary Timothy Geithner

Too Big to Fail is Too Big to Exist

Financial institutions that are “too big to fail” played a major role in undermining the American economy and driving our country into a severe recession.

Financial institutions that are “too big to fail” put taxpayers on the hook for a $700 billion bailout and more than $2 trillion from the Federal Reserve in virtually zero interest loans.

Huge financial institutions have become so big that the four largest banks in America (JP Morgan Chase, Bank of America, Wells Fargo, and Citigroup) now issue one out of every two mortgages; two out of three credit cards; and hold $4 out of every $10 in bank deposits in the country.

Just five banks in America (JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley) own a staggering 95% of the $290 trillion in derivatives held at commercial banks. Derivatives are risky side bets made by Wall Street gamblers that led to the $182 billion bailout of AIG, the $29 billion bailout that allowed JP Morgan Chase to acquire Bear Stearns, and the collapse of Lehman Brothers.

The concentration of ownership in the financial services industry has resulted in higher bank fees and interest rates that consumers are forced to pay for credit cards, mortgages and other financial products.

No single financial institution should be so large that its failure would cause catastrophic risk to millions of American jobs or to our nation’s economic well-being.

No single financial institution should have holdings so extensive that its failure could send the world economy into crisis.

We believe it is time to break up the banks and insurance companies which are too big to fail.

We believe that passage of The Too Big to Fail, Too Big to Exist Act is essential for a strong American economy and a secure future for ourselves, our children, and our grandchildren.

We urge the immediate enactment of the Too Big to Fail, Too Big to Exist Act, which directs the treasury secretary to compile a list of those financial institutions that are too big to fail in the next 90 days, and to break up these banks and insurance companies a year after the legislation is signed into law.

Monday, November 02, 2009

Humor Break: Forklifts and Russian Vodka

FT - Roubini: "Inevitable Bust"

The man who seemed to have called last year's crisis believes that the low interest rates and falling dollar are creating a massive bubble that will end in an "inevitable bust", says Roubini:

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

This is all leading to another asset bubble:

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and makes the foreign currency profits of US corporations abroad greater in dollar terms.

So when will this bubble burst? The answer is that the party might go on for sometime, as we've experienced with past bubbles, they can last much longer than anybody expects, Roubini concludes:

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.

We don't know the day or the hour, but at some point this new house of cards must fall.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, October 27, 2009

Thursday, October 22, 2009

Two "Too Big Too Fail" Articles Worth Reading

NY Times writes about Paul Volcker wanting to bring back Glass-Steagall

Bloomberg's Jonathan Weil talks about Goldman and their denial of government backing

Both articles support my position that we've allowed to much systemic risk to be placed in too few organizations. No financial institution should be Too Big Too Fail. We should not regulate "systemic" institutions we should break them up.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, October 21, 2009

Don't Extend Cash for Clunker Houses

The Federal Reserve is on track to spend (read print money) to buy $1.25 Trillion in Government Agency bonds (Fannie, Freddie) in an effort to keep mortgage rates down - subsidy number 1. The government is giving away $8,000 to first time home buyers if they close before November 30th, 2009 - subsidy number 2. The mortgage interest deduction, subsidy number 3. The capital-gains exclusion, subsidy number 4. Fannie and Freddie provide liquidity to the market, but are guaranteed by taxpayers, subsidy number 5. The FHA and their 3% down mortgages......subsidy number 6.

My point.....the government has helped to create the housing bubble and they are attempting to do it again by threatening to extend or expand the tax credit for buying a home (Democrats and Republicans support this). The linked to Barron's story has the following analysis from the Brookings Institute:

According to estimates by Ted Gayer at the Brookings Institution, each additional home sale generated by the $8,000 first-time homebuyers' tax credit actually costs the government $43,000.

How's that possible? Gayer figures that of the 1.9 million homebuyers that will get the $8,000 tax credit, 85% would have bought a house anyway. The price tag of $15 billion -- about twice what Congress had intended -- he reckons will result in approximately 350,000 additional home sales, at a price tag of $43,000 for each additional sale.

That's nothing compared to the tab for a possible one-year, $15,000 tax credit for all home buyers (except those with high incomes.) Gayer figured that would cost the Treasury $73.9 billion, which he estimated would increase house sales by a total of 253,000. Each of those extra home sales would cost the Treasury $292,000 ($73.9 billion divided by 253,000.)

We should not extend this tax credit subsidy.

Scott Dauenhauer CFP, MSFP, AIF

Monday, October 19, 2009

Bonus or Derivatives - Misplaced Timing

Yes, I know my title makes no sense, that is the point.

In a previous post I blasted the record 2009 bonuses about to be paid out on Wall Street, bonuses which are based upon revenue that could only have been generated thanks to taxpayer funded bailouts. The government is focusing on executive compensation though and has just stripped Ken Lewis of his 2009 income (don't cry for him just yet, he'll retire with about a $50 million package). It bothers me though that the government is involved in compensation, if it weren't for the fact that I believe the financial system is simply just a ward of the state at the moment I would be more bothered.

What really is irritating though is the fact that Derivatives, specifically Credit Default Swaps are not garnering more attention. Buffet once called derivatives "financial weapons of mass destruction" and 2008 proved him correct. However, instead of waging war on the enemy (derivatives) we are waging it on executive compensation (which is miniscule in terms of risk).

I don't want derivatives banned, instead I want them regulated in a manner that makes sense. Making sense means that the issuance of a derivative product cannot make your company a systemic threat to the financial system. It means that if you issue an insurance policy you better have reserves to pay for it (Credit Default Swaps are nothing more than a life insurance policy on a company, if the company dies (goes bankrupt) it pays out). CDS should not be allowed to be used for speculation, only hedging (there is more to this as I do understand that in order to be offered a hedge someone must take the opposite side of the trade, which is usually a speculator, but I'm trying to keep things simple here).

What I'm trying to get at is that we shouldn't have a dozen companies owning CDS on another company and in the position to profit if that company goes bankrupt, it provides an incentive for that company to go bankrupt. This is why there is a concept in life insurance called "insurable interest," which basically means that you can't buy insurance on just anybody. If you could buy life insurance on anyone there would be severe moral hazard as you could profit if that person dies (which leads to a big mafia business in ensuring the policy is collected on, if ya know what I mean).

Our four largest banks are the biggest issuers of these derivatives and are so interconnected into our financial system that one failure would collapse them all. We must extricate these banks from these types of transactions and only allow non-systemic companies to issue such derivatives. We must make our banking system smaller and our banks should not be acting as investment banks - Glass-Steagall 2.0 needs to be imposed.

Finally, we need to do something about the top bank, The Federal Reserve. It has accumulated to much power and used it in non-transparent ways, accomplishing the exact opposite of its founders intentions (actually its accomplishing everything its founders intended, just not what they sold it as). The Fed has not stopped the formation of bubbles or lessened the boom-bust cycle, in fact it has made it worse and devalued our currency in the process.

Bonuses and executive compensation are important, but they are shareholder issues and thus the best way to address them is to address the bigger issues and get the government out of owning the financial system (but regulating it....which they haven't proved able to do) and give the power over executive compensation back to shareholders (where it hasn't been....partially due to mutual fund ownership).

We continue to spend our time and outrage over bonuses that seem huge (and they are) but are pennies compared to the larger issue of derivative time bombs (we are talking billions versus trillions).

Scott Dauenhauer CFP, MSFP, AIF

Tamny: Inflation vs Deflation

My Starbucks Frappachino now costs 6% more ($.25) as of last this a sign of inflation or the taking advantage of an addict?

In my previous column I talked about Deflation and Inflation, the linked to article does a great job in explaining the Inflation issue.

"Most notably, deflation's advocates point to falling prices for certain goods, such as cars, clothes and hotel rooms, as evidence that the general price level is falling. The problem at first glance is that falling prices in isolation are not evidence of deflation.

Consider hotel rooms in New York City. Relative to three years ago, they've become much cheaper. But far from evidence of deflation, falling hotel prices merely expand the range of goods visitors to New York can purchase. If hotel rooms cost $200 less per night, tourists by definition have $200 more to spend on other goods previously out of reach. The impact on New York's price level is zero."

Scott Dauenhauer CFP, MSFP, AIF

Friday, October 16, 2009

WSJ: The Banking System Is Still Broken

Ann Lee is echoing what I said in my previous post (or am I echoing her?) about the financial sector, I encourage you to read this short opinion piece.

The banks have no incentive to lend. Most of them still have a significant amount of bad loans sitting on their books that they don't want to recognize as nonperforming. If the banks recognize these bad loans, all the write-offs may force them into bankruptcy. Instead, they hope that over time renegotiated loan terms will eventually allow the borrowers to make their payments. This ordeal could last at least a decade if this cycle is similar to other crises, like Japan's lost decade of the 1990s. As the fed funds rate goes to zero and existing loans in technical default continue to sit in bank portfolios, why should banks make new loans when they can make money for free with the government? There is no longer a stigma associated with borrowing from the Fed, so banks can earn a huge spread by borrowing virtually unlimited amounts for nothing and lending that same money back to the Treasury.

Scott Dauenhauer CFP, MSFP, AIF

Wall Steet Bonuses: To Demagogue or Not

Bonuses on wall street are about to set a record according to the wall street journal, potentially $140 Billion. Some people are not happy about this, count me one of them. On the other hand I'm not real big on government telling private businesses how much they can pay their employees - that is the job of the shareholders. Which brings me to my point - WE OWN WALL STREET. Wall street would not exist without the American people and the massive government bailouts of the past two years. I'm a capitalist at heart, however we do not have capitalism in our banking and financial services sectors, we have a hybrid of Capitalism and Socialism where bank profits goes first to the elitists running the company, then to the shareholders but big losses accrue to the taxpayer. This is the same thing that happened with Fannie and Freddie - there is a moral hazard that companies that know they can't fail will take on extra risk in order to obtain extraordinary profits and that risk is financed with low interest rates by institutions who also feel the government will bail out these institutions (and hence themselves) if anything ever went wrong. Why do you think so much effort was made not to wipe out the bondholders or at least force the bondholders of these large firms to take the first losses, instead of the taxpayers? There is a wink and a nod that if you can build your company to be so big and intertwined that you will not be allowed to fail - this is at the heart of our financial problems.

So when Wall Street is patting themselves on the back for a job well done, when the reality is that they have helped to destroy the very fabric of America (along with their friends in the government) the rest of America settles in to whether the first depression since the Great One. We have 17% unemployment and Goldman Sachs is set to pay on average over $500,000 per employee in bonuses. Goldman Sachs would not be standing today without the government bailouts of AIG, TARP and the allowance of them turning into a bank holding company. Privatization of profits, socialization of losses is not capitalism and it will destroy our financial system (it already did, its now on life support and in reality needs a blood transfusion).

Capitalism is based on failure, without failure there is no capitalism - just socialism and communism. Our financial services sector needs a massive amount of reform. If a company wants to pay huge bonuses, great, I encourage that and am happy for the people who receive those long as those bonuses are based on an insurance policy that WE have to pay out on when that company fails. We don't need a pay czar, we need to separate out institutions that are too big too fail and break them up. We need to have rules for entities that rely on the government (FDIC deposit institutions) and rules for those that don't and be firm that the USA will no longer come to the table and bail out companies when they get into a mess. We need to ensure that if they do overleverage that it will not cause taxpayer bailouts.

I've got so much more to say on this, but I think you get the point - being against Bailout Bonuses is not anti-American, its pro-America - we must destroy To Big To Fail to save a country that the world knows is too big too fail.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, October 15, 2009

Foreclosures: 'Worst three months of all time'

"They were the worst three months of all time," said Rick Sharga, spokesman for RealtyTrac, an online marketer of foreclosed homes.

During that time, 937,840 homes received a foreclosure letter -- whether a default notice, auction notice or bank repossession, the RealtyTrac report said. That means one in every 136 U.S. homes were in foreclosure, which is a 5% increase from the second quarter and a 23% jump over the third quarter of 2008

Wait till the $8,000 credit expires and the effects of the 90 day foreclosure moratorium in California coming to end start showing up in the numbers, not to mention the resets that are in their infancy. The current foreclosure crisis is much worse today than ever before, yet you wouldn't know it by the way the bank stocks and the stock market is trading.

Scott Dauenhauer CFP, MSFP, AIF

This Bull Has Destroyed Future Retirements

You won't hear this from any other source, the current bull market is destroying retirement savings.

But the market is up over 50% from its March lows, this is good isn't it? Well for those who managed to stay in stocks or switch back to stocks at some point since March this rally has been impressive and great for a person's retirement savings (unless of course things fall apart again). Today, stocks are now trading at around 20 times trailing 10 year Price/Earnings, whereas in March they were at around 12. Research shows that the higher the P/E you pay, the lower your returns over the following 20 year period. In other words retirement participants could have expected more money in retirement if they were given more time to invest at the March lows. Let's pretend the market stayed where it was at in March of 2009 and slowly rose over the next 20 years - retirement plan participants who have money taken out of their paychecks would be investing at much lower prices and thus could expect a higher rate of return. Now that stocks have risen to full value (many would argue they are overvalued) the return that can be expected is much less (and the downside much greater). In other words, this quick rise in stocks destroyed one of the best opportunities for retirement plan participants to create wealth for their retirement, by investing at low prices (remember, buy low, sell high!).

If this Bull market has done anything it has perhaps bailed out some investors who can now sell into the market and reduce their risk exposure to what is more appropriate for them. Hopefully a lot of investors are able to take advantage of this, but retirement plan participants who need to contribute for the next 20 years should be hoping that stocks fall, giving them the ability to accumulate at reasonable prices - which will create much more wealth for them in the future then this current bull.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, October 13, 2009

Inflation or Deflation?

It seems like I keep coming back to this theme - are we in for Inflation or Deflation? In past blogs I've argued for both and favored the Inflation view. I'd like to update you on my current thinking, which is to say I still don't know the future and the present is getting tougher and tougher to figure out. I like to style myself as somewhat contrarian, thus when I was buying TIPS (Treasury Inflation Protected treasury bonds) back in November when everyone else thought we were entering a deflationary cycle, yields were over 3% real. I've written a lot about the printing presses of the Federal Reserve and the devaluation threats we face with a currency that is overleveraged and increasingly increasing in the amount available. I've stated that Inflation is the real threat. I still believe inflation is a huge threat, however the consensus view has now changed to agree with me and that makes me question whether I am right. Its not that the consensus is always wrong, its just wrong often enough to scare me when I'm in the consensus.

So here is the Inflation story in a nutshell:

The Federal Reserve is printing money faster than at anytime in history (that I'm aware of)

That printing of dollars leads to more dollars, whenever you have more of something it is worth less

Worth less dollars quickly become "worthless"

$1 in 1800 would buy you MORE in 1913 (50% more) than in 1800, In 1913 the Federal Reserve was created and today the dollar buys 99% less (its worth the equivalent of 8 cents in 1800 dollars, I say 99% percent because the dollar peaked at $2.04). See Sean Malone's Rise and Fall of the Dollar

We have a history (other than the Great Depression) since the Federal Reserve was created of inflating our currency.

The United States is in a debt spiral, our National Debt is approaching $12 trillion, or annual deficit will be $1.6 trillion this year and our off-balance sheet debt is between $50 and $105 trillion depending on who is counting it.

With all this debt there is no choice but to inflate the currency and "inflate our way out of this mess"

Essentially this is the conventional wisdom. I actually believe most of this and think that long term, inflation is a huge threat.

But what of deflation? Are we seeing inflation right now?

Gas prices are going up, but are still lower than a year ago

Home prices are lower and despite what the media says, going lower or stagnating

Restaurants haven't raised prices and I'm getting much better deals when I go (I see more Happy Hour's!)

Cars are not significantly cheaper, but they aren't rising in cost (okay, they were cheaper when subsidized with Cash for Clunkers)

My Internet, Cable and Phone are cheaper and I have more services

Wages are not going up, they are dropping and people are taking pay cuts or forced furloughs (or being fired)

Airline tickets are not higher (even with higher oil prices)

Hotel prices are not higher, they are much lower in some cases

My point? We are now experiencing deflation, despite the best efforts of the Federal Reserve. The only place we see inflation is in commodities and asset prices (Gold, Stocks, etc). Right now deflation is winning. If you're looking for a model where a country printed lots of money and didn't experience inflation......look no further than the second largest economy in the world - Japan (for now at least).

How could we have deflation with so much money being printed? The money is not being put to work. There is a tremendous demand for safety right now and U.S. citizens are putting their money into banks, who are not lending the money out (which creates reserves and excess reserves). This huge demand lowers the amount of interest a bank must pay (supply and demand always win out).

What many are leaving out of the inflation debate about printing money is Velocity of Money. Though some recent research points out that its the banks creating money, not the federal reserve that leads to excess reserves and more Fed printing, I'm not yet convinced. Here is the simple explanation. The Fed prints money and that money sits on deposit with the banks, but if the banks don't lend that money out (which they are not because their balance sheets are impaired and they are scared of the marketplace right now (self-fulfilling prophecy)) the money doesn't circulate and multiply. Velocity is simply a measurement of how often a dollar gets recylced through the system. If an individual applies for a loan to buy a car and that loan is granted then $30,000 is lent to buy the car and is deposited into another banks account, creating new money (this is called fractional reserve banking), if that bank decides to lend that money and there is a borrower worthy, the money continues to circulate and more and more money is created (sounds weird and my explanation is terrible). The point is that if people aren't spending and if banks aren't lending, there is no velocity and thus no leveraged money inflation.

To be fair, the inflationists (of which I am one, but I'm also a do you like that!) don't believe we are in an inflationary cycle now, but that if banks become more confident and put those excess reserves (which are massive) to work and start lending again we could see a bubble even bigger than before as banks routinely will leverage themselves by a factor of 12 - 20 (meaning that for every $1 the Fed creates, the banks turn it into $12 or $20), this would lead to mass inflation.

If you're confused, don't worry, you are supposed to be. The government and Federal Reserve have set up a system that is absurd and the more you don't want to know about it, the easier it is for them to get away with just about anything.

Many will argue that the Fed's goal is to inflate our way out of this massive debt we've accumulated and they are right to an extent. China is nervous as are other countries which is why the dollar has been falling, but make no mistake, the dollar is still king....for now. In a panic, people will clamor for dollars (unless of course that panic is induced by a mass devaluation). Believe it or not the $12 trillion is not our biggest problem. A problem it is and it must be addressed, however the real problem is the one that CAN'T be inflated away - Entitlements. Social Security, Medicare and Medicare Part D (not to mention Medicaid) are REAL obligations, meaning that the value can't be inflated away - the only way to reduce these deficits is to raise taxes (by a lot) or reduce benefits (actually technology can also reduce these well as increase them).

We have a huge debt problem and if not faced head on and soon, it threatens our way of life and that of our children and grandchildren.

We are in a depression right now and deflation is winning the day. How long this will last, I don't know, but we need to be prepared for both scenarios.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, October 08, 2009

FHA Needs A Bailout.....Duh.

As if this is going to come as a surprise, the FHA is in need of a bailout and guess who's going to provide it?

It didn't take a rocket scientist to know that this was coming, the FHA has become the new subprime lender in this country offering loans that are effectively 100% (no down payment loans) and many times the loans are made to people with less than perfect credit. The FHA even has a refinance program that allows a refinance up to 125% of LTV (loan to value) and I've been told there is no credit check for this if the refinance is being done on an FHA existing loan.

Housing is continuing to kill the economy and the current programs to address it are not working (modification, monetization and more sub-prime type lending). We need a real solution, its starts with sound lending, sound money and a program to put an end to the foreclosure/mortgage crisis that is worse today than it was a year ago.

The solutions are out there, I've even written about them.

Scott Dauenhauer CFP, MSFP, AIF

Edward Pinto Testimony

Tuesday, October 06, 2009

Hayman: The World Is Printing Money, A Lot Of It

So you made several hundred million from predicting the subprime massacre, what do you do for an encore? Kyle Bass runs Hayman Advisors, a hedge fund that did quite well during the downturn (though is down 17% this year) and he believes we are in for massive amounts of inflation, globally. I don't expect you to read his 24 page quarterly report, but I actually sat down with a cup of coffee and did.....its not pretty. If you thought the US was printing money, you should see China (and Japan). The world is attempting to recover from last year's devastation by reflating and printing money. The global economies are responding to over-leverage by......adding more leverage.

Scott Dauenhauer CFP, MSFP, AIF

Hay Man

Monday, October 05, 2009

Graham Summers: The Next Major Crisis Brewing

As I've tracked the Federal Reserve's operations this summer I've become increasingly uncomfortable with what I saw. Instead of writing what would turn out to be a highly technical and probably boring piece about debt monetization, failed treasury auctions and open market operations I'd like to point you to a piece by Graham Summers that I think explains my concerns, you can click on the title above to access the entire piece, I'll give a few tidbits below:

For the Fed to hint at raising rates (let alone raise them) would kick off a systemic implosion that would wipe out the very guys the Fed has been bailing out. Suffice to say the Fed won’t be raising interest rates now or anytime too soon (within the next 3-5 years, unless inflation destroys the dollar).

The Fed also announced it would be slowing its purchase of Mortgage-Backed Securities (what I call the Fed’s “cash for trash” program). The Fed has stated previously that it will buy $1.45 trillion in mortgage-backed securities from US banks and that this program will end by the end of 2009. However, last week the Fed said it will be extending the program (but not the amount of money spent) until the first quarter of 2010.

The Fed did announce that it would let its Quantitative Easing program end in October. If you’re not familiar with this program, it’s basically a fancy way of saying that the Fed has been buying US debt in order to finance Obama et al’s massive deficit.

This particular development is key. A little known fact (and one totally ignored by the mainstream media) is that the Fed accounted for nearly half of all Treasury purchases in the second quarter ($164 billion out of $339 billion). In fact, the Fed bought more Treasuries than the next three largest purchasers combined!!

The Fed’s purchases outnumber foreign holders (foreign governments), US households, and Primary Dealers (mega banks) combined. One should also note that foreign holders reduced their purchases of US debt from $159 billion in 1Q09 to $101 billion in 2Q09 (a 40% decrease).

In simple terms, these numbers indicate that if it were not for the Fed, the US Treasury market would have almost assuredly had numerous failed auctions in the second quarter.

I’ve often stated that the Fed will have to sacrifice stocks or the US dollar. If the Fed does in fact end Quantitative Easing in October (as it has stated it will in last week’s FOMC), then we’ll see what the market really thinks of US debt as an investment class. It’s clear from the above data that foreign holders want higher rates (yields) in order for them to start buying more heavily. However, as I’ve stated before, the Fed cannot afford higher interest rates without blowing up US banks.

The Fed is no longer walking a tightrope, it is now attempting to keep the box it is standing on front tipping over....which would tighten the noose around its next and....well you know how that ends. The rope is no longer what the Fed is walking on, its what is around their neck.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, September 30, 2009

Have We Learned Nothing?

Michael Pomerleano writes that nothing has changed in terms of regulating our global financial system, he is afraid of another crash, I encourage you to read this article, what follows are a few excerpts:

Considering the number of luminaries attending — Christina Romer, head of the Council of Economic Advisers, and Kevin Warsh, a member of the board of governors of the Federal Reserve System, among others — I expected to find a strong shared sense of direction and a determination to take the correct steps following the financial carnage. I did not.

Foreign participants free of official shackles or self-imposed loyalties to past institutional affiliations were forthright. Andrew Sheng of the China Banking Regulatory Commission reproached us for thinking that throwing debt at a global problem of insolvency will succeed. He presented striking data. The subprime losses of $150 billion in 2007 required US government aid of $13.2 trillion as of 19 June 2009. In 2008, salaries of the top 10 banks reached $75 billion (up from $31 billion in 1999), while cash dividends to shareholders were only $17.5 billion. Management took 4.3 times more than shareholders at a time when shareholders were injecting capital and government was guaranteeing deposits. He pointed to the critical principal-agent fiduciary problem. Essentially, financial sector losses will be paid for by future taxation (large fiscal debt) or inflation. To this I add that the US Treasury “stress tests” led to an injection of roughly $67 billion in 2009. This year alone, the committed bonuses are more than $75 billion.

Francesco Papadia of the European Central Bank observed at the conference that in Europe there is no debate about the ECB. I can only conclude that both the EU and the US are tolerant, naïve societies prepared to accept the loss of our future to regulators and financiers. Sadly, the indifferent attitude in Europe and the debate in the US are leading to a path of no reform, and the financial system will game the taxpayer again.


Scott Dauenhauer CFP, MSFP, AIF

Idiocranomics: Re-REMIC's...More of the Same, Did We Learn Nothing

When I read this Wall Street Journal article I about fell out of my chair. I honestly thought it was a parody, something you'd see on The Onion, its not.

In essence a Re-REMIC is a repackaged pool of loans....or a re-repackaged pool of loans! Banks and Insurance companies are upset that they can't sell the junk on their balance sheet and they are ticked that they have to actually hold capital against lousy assets, so they came up with a scheme to package junk assets with seemingly "good" assets, pay a ratings company to turn the entire package into a AAA rated security so that they can hold the same assets on their balance sheets......but with less capital. Does any of this sound familiar to you? Anyone?

"There is $350 billion to $400 billion in market value of securities with no natural buyer due to their rating," Barclays said in a June report. "The re-remic market provides a way out of this gridlock by creating new AAA securities, which are likely to be viewed as attractively priced."

It is quotes like the above that make me want to both laugh and cry because they are so incredibly stupid. So the bank holds assets that there is "no natural buyer" because they are poorly rated....this is total and complete baloney - every asset has a buyer at the right price. Secondly, if you put lipstick on a pig, you still have a pig - but the Wall Street magic combined with a small payoff to one of those trusted rating agencies turns the pig into something, a Stallion if you will. This is the same financial alchemy that was at the heart of the financial crisis.

A year later and we've learned nothing.

Scott Dauenhauer CFP, MSFP, AIF

Monday, September 28, 2009

No-Money Down...Back in 2005!

Hussman: Tradeable PAR's = Solution to Mortgage Mess

If you don't read John Hussman's Weekly Commentary, you are missing out (find it at This week's commentary is especially brilliant, not just because of the market commentary (he is not optimistic), but because he continues to provide details of a system that would help to solve our nations mortgage mess (no it has not been solved and its about to get much worse) without much help from the taxpayer. I've provided an excerpt below, but you should really read the entire commentary.

The mechanics of PARs

On the mortgage side, I noted in March (On the Urgency of Restructuring Bank and Mortgage Debt, and of Abandoning Toxic Asset Purchases) “If there is any good news at present, it is that the capital infusions of late-2008 have temporarily stabilized the banking system, and that the U.S. economy is presently enjoying a brief and modest reprieve from the financial crisis. This is largely the result of an ebbing in the rate of sub-prime mortgage resets, which reached their peak in mid-2008, with corresponding mortgage losses and foreclosures a few months later. Since this crisis began, the profile of mortgage resets has been well-correlated with subsequent foreclosures. This reset profile is of great concern, because the majority of resets are still ahead. Moreover, the mortgages to which these resets will apply are primarily those originated late in the housing bubble, at the highest prices, and therefore having the largest probable loss. Undoubtedly, some Alt-A and option-ARM foreclosures have already occurred, but the likelihood is that major additional foreclosures and mortgage losses lie ahead. If we fail to address foreclosure abatement during the current window of opportunity (early to mid-2009), there may not be time for legislative efforts to contain the resulting fallout.”

We have done nothing material on this front. I continue to believe that foreclosure abatement requires debt restructuring. Short of major voluntary write-downs by lenders, which are unlikely, the best approach would be to use the Treasury as a coordination mechanism to administer what I've called “Property Appreciation Rights” or PARs (skip to the next section if you believe the credit crisis is over).

Here is some additional detail on how these might work. A homeowner with a mortgage of say $350,000 would renegotiate the debt with the lender, replacing it with, say, a $200,000 mortgage obligation plus a $100,000 PAR (and an outright reduction of $50,000). The PAR would not be payable directly from the homeowner to the mortgage lender. Instead, two things would happen. First, the homeowner would owe the PAR amount to the Treasury out of any future appreciation of the home, or if sold, appreciation on subsequent property, and ultimately out of the homeowner's estate (possibly less some exclusion based on the size of the estate). Second, the Treasury would aggregate all PAR payments received from the pool of homeowners owing them, and would distribute them proportionately to the mortgage lenders holding the PARs. In this way, the PARs would be fully tradeable and investable instruments, similar to closed-end mutual fund shares, with the Treasury acting essentially as a payment collector (through the IRS) and transfer agent. The PARs would most likely trade at a discount to their face value. More on that below.

In order to prevent advantages or disadvantages based on the date one enters the PAR pool, new revenues would be distributed to PAR holders in proportion to their remaining unpaid claims. The “Face Value” of each share would be calculated by the Treasury as the ratio of unpaid PAR claims to the number of PAR shares in existence. In practice, it would be reasonable to have several “tranches” of PAR shares, reflecting differing loan-to-value (or better yet, PAR-to-value) classes, which clearly have differing probabilities of being paid off in full.

For example, suppose the pool begins with $100,000 in PAR obligations from a homeowner, and the Treasury issues 100,000 PAR shares to the mortgage lender, for a Face Value of $1 a share. If $20,000 of payments are made, the new Face Value for a share would be reduced to the ratio of Unpaid Claims to Outstanding Shares, or $0.80.

Suppose now a new $100,000 of obligations enters the pool. In this case, the mortgage lender receives 125,000 PAR shares ($100,000 / $0.80). There are now $180,000 in unpaid obligations, and 225,000 outstanding shares, not surprisingly, representing $0.80 of unpaid claims per share. If a payment of $45,000 was now received, $20,000 would go to the mortgage lender who has 100,000 PAR shares), and $25,000 would go to the second lender (who has 125,000 PAR shares). In each case, the amount received is proportional to the outstanding amount of unpaid claims due to each holder.

Would the PAR securities trade at face value? Probably not, and that is a great advantage, because it provides a natural way for the underlying mortgage debt to be restructured while at the same time pooling the losses across all participants.

Specifically, in addition to satisfying payment of a PAR obligation by paying money to the Treasury, the homeowner could tender PAR shares (purchased on the open market) directly to the Treasury, and have the obligation canceled at the then prevailing Face Value of those PARs. I know that sounds complicated, but consider an example.

Suppose that a homeowner has a $100,000 obligation to the Treasury. Suppose also that the current Face Value of a PAR is $0.80, and PAR shares can be purchased on the open market (from mortgage lenders liquidating their questionable loans) for say, $0.60 a share. In lieu of paying $100,000 to the Treasury, the homeowner could tender 125,000 shares ($100,000 / $0.80 face value), to the Treasury, which would in turn retire the outstanding PAR shares as well as that homeowner's obligation. As a result, the Face Value of other outstanding PARs would be unchanged, so no existing holder would be helped or harmed by the transaction. Those 125,000 shares would cost the homeowner only $75,000 on the open market, even though it would cancel a $100,000 obligation.

This is important: notice that what has happened here is that some existing PAR holder has, in effect, negotiated a reduced mortgage settlement with some homeowner (in this case, a $25,000 reduction in the mortgage obligation), canceling that portion of the mortgage debt, even though the PAR holder may not have been that specific homeowner's lender in the first place.

In short, by creating a tradeable instrument, administered by the Treasury (but not requiring any public funds other than those administration costs), a market mechanism would be created to settle troubled mortgage obligations, even between unrelated participants.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, September 22, 2009

Idiocranomics: Ken Fisher Says We Need More Debt...What?

If this video doesn't blow you away I don't know what will. Here is a guy (warning, he's among the most narcissistic money managers around) who argues with a straight face that the United States is "underindebted" or we don't have enough debt. He then perpetuates the myth that we had more debt at the end of WWII than we do now (which is true if you exclude entitlement debt which is off-balance sheet).

This is truly unbelievable, the US is not "underindebted" it has way too much debt and its getting worse. Why anybody gives this guy any credibility is beyond me.

Scott Dauenhauer CFP, MSFP, AIF