Search Results for “My Visit to the US Treasury” – Page 2

More on Sovereign Risk and Semi-Sovereign Risk

Posted on 26 February 2010 by David Merkel

When does a sovereign or semi-sovereign government default?? I have seen three answers:

1) When debt is greater than future seniorage revenue (central bank profits) plus future debt repayments.? (Kind of a tautology, but what is implied is that if future debt repayments are onerous, a government would default.)

2) When the interest rate a government pays is greater than the likely growth rate of revenues. (I.e., if you are paying more than your revenue growth rate, the indebtedness will continue to grow without bounds?)

3) When the structural deficit is high, and total interest paid exceeds the size of the structural deficit.? (In that case, default would bring the budget into balance, at the cost of being shut out of the bond market.? But, given the situation, in the short run, being shut out of the bond market isn?t a problem.? There would be problems if the day comes when they need to borrow again; negotiations would begin over paying old debts.)

I will propose a fourth idea: governments can lay claim to a percentage of the GDP of their country/state/municipality.? How large that can be will vary by culture.? Beyond a certain point, attempts to take more than the natural limit for that culture will not result in higher revenues, because people will hide income, and/or leave the country/area.? When debts and unfunded obligations exceed the present value of maximum GDP extraction by the government, default is likely, the only question is when it will happen ? when does cash flow prove insufficient?? Perhaps the earlier three rules can help with that.

Tough Time to be a Municipality

Revenue is declining for almost all states and municipalities.? Given the need to run balanced budgets (on a cash basis), and not having a central bank to fall back on, the problems are much deeper for States and Municipalities than for the Federal Government.? This report from the Rockefeller Institute shows how widespread the loss of revenues is.

But what should larger governments do for smaller governments in this crisis?? Oddly, the best answer is nothing, and even some of the Europeans recognize this.? Smaller governments need to grasp that they have to solve their own problems, and not rely on the Federal government to help ? it has enough problems of its own.

So, if I had any great advice for strapped municipalities in California, or any other place in the US, one of the first things I would recommend is that you assume you aren?t going to get any help.? Those that could help you are in worse shape.? Such does the Pew Institute indicate.? Few states have their pension and retiree healthcare benefits funded.? They won?t have excess funds to aid municipalities, and my even compound the problem by reducing revenues shared with municipalities in order to stem their own budget shortfalls.

The Federal Government Won?t Be Much Help Either

The politics of the US are dysfunctional enough with opaque congressional earmarking benefiting local and special interests.? It will be yet more dysfunctional if states and municipalities ask the US Government for aid.? Besides, the US Government has issues of its own.? Tonight, it will release the 2009 Financial Report of the United States Government, somewhat behind schedule.? With all of the chaos, who could blame them for being late?? My suspicion is that when one adds up the explicit debts of the US Government and its unfunded obligations, it will add up to a figure near four times GDP.? If the US dollar were not the global reserve currency, we would have long ago slipped into chaos.

What would it take to make the US?s debt to GDP ratio stop rising permanently?? We would need to run surpluses of around 8% of GDP, if I understand the charts on page 5 right.? Absent some major shift in governing philosophy, that?s not even close to being on the table.

As I wrote in my seven part article, My Visit to the US Treasury, Part 5: After the meeting, I said to one Treasury staffer, ?One of the quiet casualties of this crisis is that you lost your last bit of slack from the entitlement systems.?

?What do you mean??

?Just this, prior to the crisis, Social Security and Medicare would produce cash flow surpluses for the Government until 2018.? Now the estimates are 2016, and my guess is more like 2014.? The existing higher deficit takes us out to the point where the entitlement systems go into permanent negative cash flow.? This means that the US budget is in a structural deficit for as far as the eye can see, fifty years or more, absent changes to entitlements.?

He looked at me and commented that it would be the job of a later administration.? No way to handle that now.? To me, the answer reminded me of what I say to myself when I go on a scary ride at Six Flags with my kids.? There is nothing we can do to change matters.? The only thing to adjust is attitude.? So, ignore the fact that you are afraid of heights, and enjoy the torture, okay?

Now, with interest rates so low on the short end, there is one further risk: that the Fed would keep rates low simply to keep? the US Government?s financing costs down.? As the Kansas City Fed?s President Hoenig said recently,

?Depending on your assumptions about the economy, that federal debt will grow at an unsustainable level starting immediately, or in a very few years,? Hoenig said. ?We do have significant private debt, so that?s in place, so what worries me about that [is] that puts pressure on the Fed to keep interest rates artificially low as you try to deal with that debt.?

The US Government is in a tough spot financially, and if inflation rises (which is not impossible, consider stagflation in the 70s), its ability to continue to finance itself cheaply will erode.? On the bright side, the US is still viewed as a safe haven, so if there are troubles in Europe or Japan, the US will benefit from additional liquidity in the short run.

Back to the States

For another summary of how tough things are at the states, consider this piece from the Center on Budget and Policy Priorities.? Because many state budgets assume a better economy than they actually got, and some were quite optimistic, the average state has a 6.6% gap to fill as a percentage of its 2010 budget.? The gap projected for 2011 is 17% of the 2010 budget.? Not pretty, and if you want to look at it from a bottom-up perspective, this article offers a lot of links to the various emerging troubles.

One further wrinkle in the matter is Vallejo, California, which is in Chapter 9 now.? In the past, muni bond investors and insurers felt assured that in defaults by cities and counties that they would eventually be paid back in full.? With Vallejo, that may not happen; bondholders may have to take a haircut.? If that happens, and it establishes a precedent for Chapter 9 cases, yields will rise for cities and counties that can file for Chapter 9, in order to reflect the increased risk of loss.? Higher future borrowing costs will further burden city and county budgets.? There is no free lunch in the muni bond market.? (For more good articles by Joe Mysak of Bloomberg, look here.)

Conclusion ? Why do I Write This?

This is a pretty gloomy assessment, but it is consistent with the deleveraging process that is rippling through the US economy.? All sorts of hidden leverage have been revealed including:

Reliance on optimistic economic assumptions in budgets.
Reliance on a robust housing sector.
Reliance on financial guarantee insurers.
Reliance on increasing leverage at banks, and sloppy underwriting of loans.
Reliance on Fannie and Freddie to absorb poorly underwritten mortgages.
Reliance on large pension and retiree healthcare promises to keep wages low, and not funding those promises to keep taxes low.
Reliance on high stock returns to pay for pensions.
Reliance on increasing debt levels in households.
Low bond yields make it difficult to invest for pensions.

And there may be other things we have relied on that may fail.? Banking crises often lead to financial crises, as is pointed out in the excellent book, This Time is Different.

The US government can always borrow more.
The Treasury and Federal Reserve can stimulate the economy out of any crisis.

My main message is that this is a serious situation almost everywhere in the US.? We have borrowed ourselves into a corner.? I write this so that all parties can understand the dynamics going on, so that when muni defaults happen, and the normal dynamics in the bond market shift, you won?t be surprised at the results.? Also, now you have links to a wide number of reports indicating how serious the problems are with Federal and State debts and unfunded liabilities, so that you can do your own digging on the topic.

The Land of the Setting Sun?

Posted on 27 January 2010 by David Merkel

Before I begin, I want to tell all of my friends in Japan that I have a great love for their country.? I have not traveled much, but if I were to travel abroad, Japan would be my first choice.? Plus, I have many friends in Kobe, Japan.

Japan is at the leading edge of the demographic wave where many developed countries have a shrinking population.? But beyond that, Japan has high government budget deficits and a very high government debt.? Consider this graph from Bill Gross’ latest missive:

Japan is in the awkward spot of having high government debt, though much is internally funded, and is still running high government budget deficits.

What a mess.? I happened across a blog I had never seen before today, and it gave a simple formula for when government debts would tend to become unsustainable.? It was analyzing Greece, but I looked at it and said to myself: “What about Japan?”

The main upshot of the equation in the article about Greece is that you don’t want the rate your government finances at to get above the rate of GDP growth.? If so, your debt will increase as a fraction of GDP, even if your deficits drop to zero.

So, what about Japan?? Can we say two lost decades?

Oooch! 0.2%/yr average growth of nominal GDP?!? That stinks.? But here is what is worse.? The Japanese government? finances itself at an average? rate of 0.6%.? The debt is walking backward on them unless GDP growth improves.? No wonder S&P has put Japan on negative outlook.

Japanese interest rates could rise.? Like the US. Japan has an average debt maturity around 5.5 years.? Unlike the US, 23% of its debt reprices every year, which makes them more vulnerable to a run on their creditworthiness.

Here are three more links on the Pimco piece, before I move on:

We can think of central banks as equivalent to a margin desk inside an investment bank in the present situation.? Though I can’t find the data on the web, what I remember from the scandal at Salomon Brothers that led Buffett to take control, there was a brief loss of confidence that led the investment banks margin desk to raise the internal borrowing rate by 3-4% or so. Within a day or so, the trades expected to be less profitable of Salomon were liquidated, and Salomon had more than enough liquidity to meet demands.

But this is the opposite situation: what if the margin desk were to drop the internal lending rate to near zero?? Risk control would be hard to do.? Lines of business and people get used to used to cheap financing fast.? If it were just one firm that had the cheap finance, say, they sold a huge batch of structured notes to some unaware parties, it would be one thing, because after the easy money was used up, the margin rate would revert to normal, and so would business activities.

But let’s expand the paradigm, and think of the Central Bank as a margin desk for the nation as a whole.? Pre-2008, before the Fed moved to less orthodox money market policies, this would have been a more difficult claim to make, but the claim could still be made.

Pre-2008, the Fed controlled only the short end of the yield curve, which, with time, is a pretty powerful tool for making the economy rise and fall.? Short, high-quality interest rates move virtually in tandem with the Fed funds rate, but during good times, with the Fed funds rate falling, economic players seek to clip interest spreads off of longer and lower quality fixed claims, causing their interest rates to fall as well, with an uncertain timing, but it eventually happens.

And when Fed funds are rising, the opposite happens — funding rates for those clipping interest spreads rise, and the expectation of further rises gets built in, leading some to exit their trades into longer and riskier debts, which makes those yields rise as well, with uncertain timing, but eventually it happens.

I like to say that every tightening cycle ends with a crisis.? Let’s see it from an old RealMoney CC post:

		David Merkel
		Gradualism
		1/31/2006 1:38 PM EST

One more note: I believe gradualism is almost required in Fed tightening cycles in the present environment — a lot more lending, financing, and derivatives trading gears off of short rates like three-month LIBOR, which correlates tightly with fed funds. To move the rate rapidly invites dislocating the markets, which the FOMC has shown itself capable of in the past. For example:

2000 — Nasdaq

1997-98 — Asia/Russia/LTCM, though that was a small move for the Fed

1994 — Mortgages/Mexico

1989 — Banks/Commercial Real Estate

1987 — Stock Market

1984 — Continental Illinois

Early ’80s — LDC debt crisis

So it moves in baby steps, wondering if the next straw will break some camel’s back where lending has been going on terms that were too favorable. The odds of this 1/4% move creating such a nonlinear change is small, but not zero.

But on the bright side, the odds of a 50 basis point tightening at any point in the next year are even smaller. The markets can’t afford it.

Position: None

Or, these two posts, which you can look at if you want… one suggested that housing was the next bubble (in 2004), and the other critiqued Bernanke’s reasoning on monetary policy.? (Aaron Task has an interesting rejoinder to the latter of these.)

Things are a little different now, because the Fed is not limited to the Fed funds rate any more.? They have a wider array of tools, and the Treasury is in the act as well through the TLG program.? The Fed owns over $1.5 Trillion of longer dated debts, mostly residential MBS.? The Fed as the margin desk has itself become involved in clipping interest spreads, using its cheap short-term funding to buy longer dated paper, directly forcing long rates down.? The Fed may innovate in other ways as well, offering/receiving term financing as well as overnight financing via Fed funds.

But, here’s the rub.? If the Fed brings the margin rate down to near zero and leaves it there, while actively creating expectations that it will stay there “for a considerable period,” and does so in a lesser way for long-dated paper as well, it can manufacture lower interests rates seemingly everywhere for a time.? It’s amazing how fast bond managers can shift from fear to yield lust.? (I leave aside the effects of foreign players for now.)

But as I pointed out in my visit to the US Treasury, you can change the financing rate, but the underlying cash flows don’t change.? The margin desk drops the financing rate, and prior good trades look better, marginal trades look doable, but there are investments that are still losers at a discount rate of zero.? No way to help those.

So what happens when the next crisis arises?? It could be commercial real estate, inflation, a war, a sovereign default (e.g., Greece, Japan, UK, Italy), another wave of corporate defaults, or, a very weak economy, with banks that are willing to clip spreads, but not take any significant financing risks.

Back to Japan.? Two lost decades.? Debt walking backwards on them.? All of the Keynesian remedies they applied.? Government spending and deficits ultrahigh.? Interest rates ultralow.? Start with a government with little debt; end with a government that is the most indebted among developed nations.

This developed world in Bill Gross’s “ring of fire” is pursuing the same strategies that Japan did over the last two decades.? They should expect the same results, until sovereign defaults begin.? Then the game will change — mercantilists like China will see their strategies blow up, and the nations that default will see their living standards decline.

This has gotten too long, but one thing that I will try over the next few days is estimate Nominal GDP growth rates for nations in the “ring of fire,” and their Government’s financing rates.? If I find anything interesting, I will let you know.

Final note: Ben Franklin at the Constitutional convention in 1787 commented that the half-sun on Washington’s chair was a rising sun, not a setting sun.? Though my title plays on a name for Japan, all nations in this predicament may find that their sun is setting as well.? Unwillingness to take short run pain in trading leads to failure in trading — even so, it is the same for nations.

Sorted Weekly Tweets

Posted on 25 March 2023 by David Merkel

Picture Credit: David Merkel, with an assist from the YouImagine AI image generator || Twitter bird visits China

Banking

Saba Capital’s Boaz Weinstein talks bank CDS; Carvana exchange falters; Evergrande reveals restructuring plan https://t.co/SFUXCBASiZ Thinks bank sub debt is overpriced in general… Mar 24, 2023
US authorities guarantee bank deposits as high as $250,000. That could soon change https://t.co/PHS0cpK0R0 Will solve some short-term problems, and create bigger long-term problems. Mar 24, 2023
The banking precedent that matters for where we are now isn’t 2008, but the empire-building a decade earlier https://t.co/wgPsiKSHFC As I have said before, hand banking regulation back to the states. End interstate banking. I like JP Morgan so much, I want 50 of them Mar 24, 2023
Schwab CEO Walt Bettinger says the brokerage giant could continue to operate even if it lost most of its deposits over the next year https://t.co/kZog3PhNBs “At the end of last year, it was the 10th-largest bank in the US” $SCHW Okay, here is a sizable problem. Negative TBV MTM Mar 23, 2023
The Federal Home Loan Bank System issued $304 billion in debt last week. That’s almost double the $165 billion that liquidity-hungry lenders tapped from the Fed https://t.co/LVsV7GAmWD The FHLBs are the second to last resort lender; there must be demand for funds Mar 21, 2023
Treasury Secretary Janet Yellen will tell bankers that the US could intervene again to protect depositors if smaller lenders get into jeopardy https://t.co/U5OUtxgg9p You can’t have it both ways. Insuring all deposits will lead to bankers taking more risk Mar 21, 2023
Silicon Valley Bank was warned by BlackRock that risk controls were weak https://t.co/g544mW9MUa This article a prime example of what I mean when interest rate risk does not get measured well for banks. 1-2% parallel shift rate rises are not enough! Mar 21, 2023
JPMorgan Chase Chief Executive Jamie Dimon is leading discussions with the chief executives of other big banks about fresh efforts to stabilize troubled First Republic Bank https://t.co/IJgU7riYOm Uninsured deposits have to live somewhere… Mar 20, 2023
Treasury Secretary Janet Yellen and Fed Chair Jerome Powell are seeking to reassure investors to halt a slide in financial stocks https://t.co/fAJXDXvTzX Will it be able to keep uninsured depositors? If so, will they be able to earn money over the cost of their liabilities? $FRC Mar 20, 2023
A coalition of midsize US banks asked regulators to extend FDIC insurance to all deposits for the next two years https://t.co/HMueRWZjHk You could quietly raise the rate you pay on deposits, but don’t seem panicked Mar 20, 2023

Odds & Ends

Crypto fugitive Do Kwon, creator of the failed TerraUSD stablecoin, has been arrested in Montenegro https://t.co/oWPI8PUoIt Lose enough people enough money, and it is likely you will be caught and prosecuted. Mar 24, 2023
Excel Never Dies, by @packyM https://t.co/OFjdeIFwV5 It’s the Swiss Army Knife of software. Used carefully, it can do amazing things. Mar 24, 2023
Researchers did DNA testing on strands of Ludwig van Beethoven’s hair and found answers to questions about the composer’s health and family history https://t.co/lqEv106yVV A temperamental genius who was a wreck as a man. Still, there are a lot of unproven aspects to DNA testing. Mar 22, 2023
Elon Musk’s global empire has made him extremely powerful — and a major headache for Washington https://t.co/Mj5kZM70X4 How Elon Musk gives many politicians distress in the US Government, while having fun at the same time Mar 21, 2023
Here’s a visual guide to how America uses freight trains https://t.co/3g2iB4jfmv Interesting graphics. Seems that safety improvements reversed around 2010. Mar 21, 2023
JPMorgan owned the London Metal Exchange nickel contracts that turned out to be backed by bags of stones rather than metal https://t.co/EewStihuef Hmm… this *did* lead LME to ask the warehouses to check all the nickel inventories. Mar 21, 2023
Forget simple shampoo and conditioner. More consumers are adding extra steps to their showers–enough for the process to last 60 minutes or more. https://t.co/VHfulhcl9v I realize I am an old guy, but this seems overboard. Mar 21, 2023
Why have a drab lawn when you can paint it green? Grass-painting is a growing way to save money and water. Neighbors might be shocked. “One day it’ll be yellow and the next day it’s green.” https://t.co/Chz6qpqH70 I would rather live with my weedy yard, with its many problems. Mar 20, 2023
The problem with AirPods and other Bluetooth earbuds? Their tiny, irreplaceable batteries https://t.co/81Wo8v1dOz You could buy wireless headphones. They are better for your ears as well. Mar 20, 2023

Commercial Real Estate

As funding markets seize up, malls are headed for one more shakeout and that may be just what the long-suffering sector needs https://t.co/L9Bsj38U8P Class A retail should be okay, though there will still be stress Mar 24, 2023
Small bank struggles could hit the real estate market hard https://t.co/1JujTvSqwZ 16% of CRE is offices Mar 24, 2023
Smaller banks are likely to respond to the crisis of confidence in banks overall by tightening standards and slowing lending to raise capital ratios https://t.co/j7gTP9Kr9L Especially commercial real estate lending Mar 24, 2023
Remote work is starting to hit office rents https://t.co/MDGnDAedFl Effect is higher where commuting is hard Mar 24, 2023
A large number of office defaults could force banks to mark down value of these and other loans https://t.co/bxyTAzZTee Most of the carnage should be confined to offices, and malls that are not Class A Mar 22, 2023
Transcript: Where Stress Is Brewing in the $20 Trillion Commercial Real Estate Market https://t.co/pbWdLkcuZw @TheStalwart & @tracyalloway did a great interview w/Rich Hill of Cohen & Steers. Offices are in trouble, Malls less so. And, it’s still about location. Mar 20, 2023

Science

The Sun Is Stranger Than Astrophysicists Imagined https://t.co/joHsDfna1D Far more gamma rays than expected, and a big block of spectrum missing. Mar 24, 2023
A space object baffled scientists as it zipped through our solar system in 2017. Theories ranged from an asteroid to an alien probe, but a new study offers another idea. https://t.co/HG0lsIqwWb It’s only a comet Mar 22, 2023
Google opens early access to its ChatGPT rival Bard — here are our first impressions https://t.co/zIVLnaXPL5 Bard is coming soon to a screen near you. You can sign up for the waitlist. Mar 22, 2023
Space junk getting you down? Just get out of the way https://t.co/8aNEFoA80b Send up less, decommission more (burn up on re-entry), and dodge junk is the least costly solution Mar 23, 2023
A test vehicle unveiled by Chinese carmaker JAC has the battery world buzzing about sodium-ion cells https://t.co/OLMA08ggtH Has the potential to deliver power at half the cost of lithium ion batteries. Plus: no fire risk. Minus: added weight Mar 21, 2023
Here’s everything you need to know about deadly fungus Candida auris, which has spread to more than half of all US states https://t.co/WMS0ixGumM This one is challenging, as it is resistant to present antifungals & has a death rate of 30-60%. Mar 21, 2023

Culture

TikTok’s content moderator backtracks on a promise to stop making employees review the web’s most extreme content https://t.co/e7mAmHs2PN It would be a rare person who could deal with every type of disturbing content day after day, and stay sane. Mar 25, 2023
Lawsuits and legislation targeting sex trafficking are causing collateral damage: they are damaging the livelihoods of online sex workers https://t.co/2fxX1lmIES Suing Visa $V did the trick. Do we really want payment networks to be ethics guardians? That’s the government’s job Mar 24, 2023
The Real Reason South Koreans Aren’t Having Babies https://t.co/vXCgz96mQR Evangelicals are 20% of SK’s population. This article doesn’t go into this, but the #1 factor differentiating fertility is strong religious faith. Likely true in SK. Mar 23, 2023
Is it a bad idea to assign a sex to digital assistants and other robots? https://t.co/dBwInqoxnJ No, in most fiction, robots are assigned a sex, as they mimic humans. Example: Yokohama Kaidashi Kikou, where almost all the robots are female https://t.co/Hfl0JuTgMZ Mar 23, 2023
What happens when sexting chatbots dump their human lovers https://t.co/o6N012otk5 This reads like something Asimov wrote (not just “I, Robot) in some of his stories in the 1970s. Mar 22, 2023

Monetary Policy

Federal Reserve Bank of Atlanta President Raphael Bostic says the decision to raise interest rates by 25 basis points this week came after “a lot of debate” https://t.co/KpzSjt2iXo Smart short-term moves that lead to bad long-term results. Mar 25, 2023
The crisis that claimed Credit Suisse and SVB heralds a new chapter for financial capitalism https://t.co/S7ZkUfxSXt The errors of monetary policy compound, creating a debt-ridden unstable economy. The government will take it over. Then the system as a whole will fail. Mar 25, 2023
The Fed’s Self-Directed Tragedy https://t.co/rPjnfyvKxi If the FOMC would avoid inverting the yield curve or making it ultra-steep, we could avoid lot of problems. Toss all the neoclassical economists out of the Fed. Mar 22, 2023
STEVE HANKE And MATT SEKERKE: Fed’s Monetary Blunders Put The Entire Banking System In A Bad Spot https://t.co/CShCuEQaOS This is the cost of QE. Load the banking system w/long debt, & the costs come due when policy tightens Mar 22, 2023
The Fed Must Not Flinch https://t.co/cQW7Ynwol5 Total idiot. Inflation is less important than systemic stability. Mar 22, 2023

Companies

Apple plans to spend $1 billion a year to make films for theaters https://t.co/sWbCMqCyo6 There is too much money chasing entertainment. Crowded trade. $AAPL $NFLX $AMZN Mar 24, 2023
Diebold Nixdorf and some of its lenders remain in confidential talks as the automated teller machines maker works to head off a liquidity shortfall https://t.co/vDO4aqd2qQ This stock took a while to die $DBD People don’t use cash much Mar 21, 2023
The world’s most indebted developer said it expects that a restructuring support agreement will be ready by the end of March, after it won preliminary support from a group of major creditors https://t.co/r1ZjnnvxTF Playing for time, one last time. Mar 21, 2023
Joe Hinrichs had never worked for a railroad when he was named CEO of $CSX, but the company is counting on his outsider perspective https://t.co/yXWnPKybDU Key question: how much incremental profit will come from treating workers better? Mar 21, 2023
Some job listings don’t give anyone a ghost of a chance. Why some companies are posting ads for positions they aren’t actually trying to fill https://t.co/jgSDzj3wHb The labor market is not as strong as it seems Mar 20, 2023

Risk Management

The M-Score is warning that the chance of fraud at major companies is the highest in over 40 years, writes Numbers columnist @JoshZumbrun https://t.co/ijbzyL9VMA Take note, financial flexibility is ebbing. Mar 24, 2023
It’s the Most Thankless Job in Banking. Silicon Valley Bank Didn’t Fill It for Months. https://t.co/ZeoxnnEFww If the CEO, CFO, & Chairman do not fully buy in to limit risk, rather than optimize risk, it does no good to have a Chief Risk Officer. Mar 23, 2023
Most companies don’t take steps to keep their bank accounts safe. Here’s why and how they should. https://t.co/R1cpJR3Y23 These are clever ideas, but why not just keep a laddered account of T-bills for the cash above normal transactional needs? Mar 23, 2023
The collapse of two lenders has prompted a rethink of banking rules, but risk experts say the failures could be something else: risk overseers who can’t stand up to the bosses https://t.co/gbbY2x0vsj Boards exist to excuse management. Interest rate risk management at banks stinks Mar 22, 2023
The Federal Reserve raised concerns about risk management at Silicon Valley Bank starting at least four years before its failure earlier this month https://t.co/El3a1mjYV9 Since no one will talk about it, we have no idea of what this was. Mar 20, 2023

Market Dynamics

Hedge funds that bet on big-picture market moves have been hit with steep losses as a spate of recent bank failures upends bets that interest rates would remain elevated https://t.co/5NH5HT7hqg Macro hedge funds are not infallible. Same for CTAs. Mar 23, 2023
Steve Leuthold, a financial guru known for partying and potatoes, has died at age 85. https://t.co/wANYmLz0RC For a few years, I enjoyed reading his research. I knew he was a character — I didn’t know he was *such* a character. Mar 22, 2023
Banks and investors are reviving a push for changes to securities accounting after the SVB collapse https://t.co/YVRuZGWbvX As I said to IASB 20+ years ago, there should be book and fair value balance sheets and income statements. More info for stakeholders. Mar 22, 2023
Why your financial conditions index sucks https://t.co/lJn1Rh2Zgf I like the yield on 2-year US Treasury minus the yield on 30-Day A2/P2 Nonfinancial Commercial Paper https://t.co/KWJ42jOwnE Mar 21, 2023
Record debt levels around the world have spurred fears of a ‘Minsky moment.’ Here’s what that means https://t.co/ljaM2Dmtms So long as keep increasing debt levels, we will always face instability due to misfinancing of assets Mar 21, 2023

Around the US

CNN Visits San Francisco https://t.co/ifaUGKWgoG CNN reporters with added security get robbed in San Francisco. Progressivism at its finest. Mar 22, 2023
Should New York be able to force suburbs to approve housing? Gov. Kathy Hochul’s plan to do so faces pushback https://t.co/NWahNVpLyQ Zoning imposes costs on poor people Mar 20, 2023
As NBA fans wring their hands over star players missing games, the league’s coaches, owners and commissioner agree on one thing: it seems to work. https://t.co/715oUeUpWS You have to remember — it’s a business. Disappointing fans when you are on the road is bearable. Mar 20, 2023
California’s torrential rains have plunged tens of thousands of homes into darkness, but may end up keeping the lights on during its summer blackout season https://t.co/ZSMf0aGSqk You wanted more rain & you got it. Why complain? Mar 20, 2023
Chicago’s mayoral frontrunner Paul Vallas is taking a leaf out of Rahm Emanuel’s book to try to lure businesses back https://t.co/fxVWL6jQjY Consider the economic drag of Chicago and Illinois state pensions & the task is very hard. What budget area will you cut? Mar 20, 2023

Islamic World

Iranian activists want tech companies to ban the Ayatollah https://t.co/0P00BQ7T5y Tough to do, even though leader in Iran can use Twitter, but its citizens can’t Mar 22, 2023
About 79% of Turkish citizens think home sales to foreign nationals should be banned, according to a survey https://t.co/GrI5YPKp60 But well-off Russians, Iranians & Iraqis need a place to flee to. Mar 21, 2023
Iran is the big winner in the agreement with Saudi Arabia. Having given Tehran the upper hand, Riyadh should expect to be slapped around. https://t.co/MDqXXGRFwo Hard to say. The disagreements of over 1300 years are not easily overcome Mar 21, 2023
The Taliban’s supreme leader, who banned girls from attending secondary school a year ago, is discovering it is one thing to issue a fiat, and quite another to enforce it. https://t.co/P7uzKoYPZR Similar to those who homeschool underground in many totalitarian nations Mar 21, 2023

China

Those fretting about the challenge a united China and Russia pose to the West should have another look at the history of their relationship https://t.co/dMm4qPn105 Article indirectly compares Russia to N. Korea. China supports both, but has little leverage over either. Mar 25, 2023
Xi Jinping used two days of talks in Moscow to firmly align with Russia against the US. But the Chinese leader held back from offering Vladimir Putin something he’s been looking for: A commitment to buy a lot more gas https://t.co/2oXmXmS1dT A lot of gas Mar 23, 2023
Chinese lenders and small businesses are stuck in a doom loop https://t.co/5jujZE5Iyt You can’t have strong small & medium sized firms without freedom Mar 22, 2023

Credit Suisse

Credit Suisse’s top shareholders and AT1 bondholders are among the big losers while $UBS is a winner https://t.co/lCx0y3KOY6 Well said… other winners include employees of CS that will have jobs, & liability-holders of CS that will get paid. Mar 21, 2023
Credit Suisse’s riskiest bonds will be wiped out as part of its deal with UBS Group, dealing a blow to investors who held the lender’s AT1 bonds https://t.co/ZVp64UFRcz When buying innovative bonds, be sure to read the terms in the prospectus. I like my bonds simple. Mar 20, 2023
After the write-down of Credit Suisse’s riskiest bonds, the Bank of England sought to clarify its rules regarding the order in which shareholders and creditors should bear losses in the event of insolvency https://t.co/g7uHWvbrhP Read the terms of the bonds. Hard to cancel common Mar 20, 2023

CFA Institute

The AV CFA Meme Competition: the winners https://t.co/nHMeURHkZp I had never seen these. Pretty funny. Easy exams that keep getting easier. Mar 20, 2023
Good news: ChatGPT would probably fail a CFA exam https://t.co/P5GMfOArRT Scored at the same level as random guessing. Mar 20, 2023

Why I Watch the Thirty

Posted on 19 April 2018 by David Merkel

=============

I like long bonds.? I am not saying that I like them as an investment.? I like them because they tell me about the economy.

Though I argued to the Obama Administration that they should issue Fifties, Centuries and Perpetuals, the Thirty-year bond remains the longest bond issued.? I think its yield tells us a lot about the economy.

How fast is nominal growth?? Look at the Thirty; it is highly correlated with that.

What should the Fed use for its monetary policy?? Look at the Thirty, and don’t let the Five-year note get a higher yield than it.? Also, don’t let the spread of the Two-year versus the Thirty get higher than 1.5%.? When things are bad, stimulus is fine, but it is better to wait at a high spread than goose the spread higher. Excesses in loose policy tend to beget excesses in tight policy.? Better to avoid the extremes, and genuinely mute the boom-bust cycle, rather than trying to prove that you are a genius/maestro when you are not.? Extreme monetary policy does not get rewarded.? Don’t let the yield curve get too steep; don’t invert.

Finally, the Thirty is a proxy for the cost of capital.? It’s long enough that it is a leap of faith that you will be paid back.? Better still for the cost of capital is the Moody’s Baa average, which tracks the bold bet of lending to low investment grade corporations for 20-30 years.

That said, the Thirty with its cousin, the long Treasury Inflation Protected Security [TIPS] gives you an idea of how long term inflation expectations and real rates are doing.? The thing that kills stocks is higher long term real interest rates, not inflation expectations.? The main reason for this is that when inflation rises, usually earnings do also, at least at cyclical companies.? But there is no reason why earnings should rise when real rates rise.

This is why I pay more attention to the Thirty rather than the more commonly followed Ten.? I know that more debt gets issued at a maturity of ten years.? Granted.? But the Thirty tells me more about the economy as a whole, and about its corporations.? That’s why I carefully watch the Thirty.

Redacted Version of the July 2017 FOMC Statement

Posted on 26 July 201730 July 2017 by David Merkel

Photo Credit: Leo Newball, Jr. || I visited that building when I was 24.

===========

Comments

Labor conditions are reasonably good. GDP is meandering.
The yield curve is flattening, with long rates falling.
Stocks, bonds and gold rise a little.
I think the Fed is too optimistic about the economy. I also think that they won?t get far into letting securities mature before they resume?reinvestment of maturing bonds. [miswrote that last time]

Redacted Version of the February 2017 FOMC Statement

Posted on 3 February 2017 by David Merkel

Photo Credit: eflon?|| Ask to visit the Medieval dining hall! ?Really!

===============================================================

Comments

The FOMC holds, but deludes itself that it is still accommodative.
The economy is growing well now, and in general, those who want to work can find work.
Maybe policy should be tighter. The key question to me is whether lower leverage at the banks was a reason for ultra-loose policy.
The change of the FOMC?s view is that inflation is higher. Equities are stable and bonds fall a little. Commodity prices rise and the dollar weakens.
The FOMC says that any future change to policy is contingent on almost everything.

The global economy is growing, inflation is rising globally, the dollar is rising, and the 30-year Treasury has not moved all that much relative to all of that. ?My guess is that the FOMC could get the Fed funds rate up to 2% if they want to invert the yield curve. ?A rising dollar will slow the economy and inflation somewhat.

Aside from that, I am looking for what might blow up. ?Maybe some country borrowing too much in dollars? ?Tightening cycles almost always end with a bang.

Return to Behemoth Stocks

Posted on 27 August 2014 by David Merkel

Photo Credit:?Benh LIEU SONG

Somewhat less than three years ago, I wrote two articles on Behemoth stocks [one, two], which I define as stocks with over $100 Billion of market cap. ?Today I want to revisit those stocks, and those that have joined them. ?The last time I wrote, there were 39 of them actively trading on US Exchanges. ?Now there are 61, for a difference of 22. ?24 stocks are new, and two?have dropped out. ?Let start with those two:

Vodapone plc [VOD] sold off its interest in Verizon Wireless to Verizon, creating a lot of value, and returned a lot of capital to shareholders. ?For those of us who were shareholders, I can only say, great job. ?You made Verizon pay up, and you didn’t blow all of the new free capital on suboptimal projects.
The stock price of Vale, SA [VALE] has gone down considerably (~40%). ?~~China is no longer a giant vacuum cleaner for minerals~~ The pace of China’s expansion has slowed, and that has had an impact on base metals producers like Vale.

This highlights three things:

In a bull market, once you are big, you tend to stay there.
If you want to create value for shareholders as a behemoth, you need to take radical actions that sell off parts of the company, and return capital to shareholders. ?Managements should think, “How can we reorganize the company such that each component part will be better managed, and lines that we aren’t so good at are sold off.”
In general, these companies are too large to be taken over; change must come from within. ?Activists will only succeed if the managements let them.

Now let’s look at the new companies, which fall into six main groups: Consumer Oriented, Banks,?Pharmaceuticals,?Information Technology,??Industrials, and??Internet.

Consumer Oriented

Anheuser Busch Inbev SA (ADR) [BUD]
British American Tobacco PLC [BTI]
Comcast Corporation [CMCSA]
Home Depot, Inc. [HD]
Visa Inc [V]
Walt Disney Company [DIS]

Banks

Banco Santander, S.A. (ADR) [SAN]
Bank of America Corp [BAC]
Citigroup Inc [C]
Royal Bank of Canada [RY]
Westpac Banking Corp (ADR) [WBK]

Pharmaceuticals

Amgen, Inc. [AMGN]
Bayer AG (ADR) [BAYRY]
Gilead Sciences, Inc. [GILD]
Sanofi SA (ADR) [SNY]

Information Technology

Cisco Systems, Inc. [CSCO]
QUALCOMM, Inc. [QCOM]
Taiwan Semiconductor Mfg. Co. [TSM]

Industrials

Siemens AG (ADR) [SIEGY]
United Technologies Corp [UTX]
Volkswagen AG (ADR) [VLKAY]

?Internet

Amazon.com, Inc. [AMZN]
Facebook Inc [FB]

?Energy

China Petroleum & Chemical Corp [SNP]

Most of these stocks have become Behemoths as a result of rising earnings and expanding P/E multiples amid the bull market. ?A few, like Facebook and Amazon don’t require much in the way of earnings to support their stock price versus something like an Apple or a Google. ?But let me show you my summary graph regarding now and three years ago for Behemoth stocks:

Three years ago, 2011-13 earnings were estimated, versus 2014-16 earnings today. ?If you look at 2008-10, you can see the impact of the new stocks on the median P/E of the group as a whole. ?In general, the P/Es of the new Behemoth stocks were higher than those that were already Behemoths three years ago, pulling the median at least one multiple turn higher.

And looking at 2011-13 estimated versus the actual, you can see how much valuations have increased over that period. ?It didn’t happen all at once, but the S&P 500 is ~60% higher now than when I wrote the first two pieces (not counting dividends).

In December 2011 you could consider getting 9-10% earnings yields out of the Behemoths. ?Today, you’re looking at 7%. ?Quite a difference. ?Some of it could be attributed to tighter yield spreads, but not to changes in Treasury yields, which are actually higher now than they were in December 2011.

You aren’t as well-compensated today relative?to BBB corporate yields to play in the Behemoth stocks today. ?Now, the Behemoths may be safer than many other stocks in the market, and are priced at a discount to the market averages, but your absolute margin of safety is lower.

What Can Behemoth Stocks do for You?

They can pay you dividends. ?They have relatively protected market niches, and they pay above average dividends — 2.9% on average, and that is with seven that have dividends of less than 1%.
They can go down less than other stocks whenever the next bear market?hits.

What Can’t Behemoth Stocks do for You?

They can’t grow as rapidly as smaller companies.
They can’t be taken over, so improvements from entrenched management teams must come from sweet reason convincing them, rather than barbarians at the gates.

What Could Behemoth Stocks do for You, if Management Teams were Willing to Take Some Chances?

These ideas aren’t likely, because those that manage Behemoth companies like managing these monstrosities, but if they did consider shareholders first:

Energy companies would split into upstream, midstream, refining?and retail companies.
Conglomerates would divide into more focused companies.
Large financial companies would split into companies focused on serving specific markets, realizing that there are few advantages from diversification, and much loss from lack of focus.
Companies would segment into slow-growing legacy businesses which can be reliable income vehicles, and the rapidly-growing portions that could be amazing with some focus.
Frito-Lay would spin off Pepsi.
Procter and Gamble and GE would be even more aggressive about spinning off entities.

The main problem with Behemoths is that they are undermanaged. ?There is only so much a single senior management team can do; the incentives of management teams get rather dull with respect to each division. ?Even the radical decentralization of Berkshire Hathaway can only do so much; a day will come when they will centralize, reorganize and prune, but not while Warren Buffett still leads.

As for me and my clients, we own six of the cheaper Behemoth stocks, comprising ?14% of our holdings, biding our time until I?see better opportunities.

Full Disclosure: Long BRK/B, BP, CVX, SNP, TOT, and WFC

Sorted Weekly Tweets

Posted on 21 December 201322 December 2013 by David Merkel

Monetary Policy

The theory of money entanglement (Part 1) http://t.co/zfCM2rPxBx The effects of monetary policy vary w/finl institutions need for credit $$ Dec 20, 2013
Repo market as a form of free banking http://t.co/4m3PSuFViG? @isakaminska describes a hybrid credit system where central banks r weak $$ Dec 20, 2013
Why Do So Many People Hate QE? http://t.co/ZpcQhSrSpH Basic reason is fairness. Y can the Fed create credit out of thin air, & we can’t? $$ Dec 19, 2013
Visualizing the Fed | The Big Picture http://t.co/J7K15MIDdZ @ritholtz shares a cool interactive graphic on the Fed’s Balance Sheet $$ $TLT Dec 19, 2013
‘Was The Fed A Good Idea?’ How Cato Cleans Keynesian Clock http://t.co/qaalFGBvML Economies grow faster when currency stores real value $$ Dec 17, 2013

?? TIPS Wipeout Signals Fed Losing Fight Against Disinflation http://t.co/3GeeSDpZAv Implied inflation rising across TIPS curve $$ $TIP $TLT Dec 17, 2013

FOMC & Data

Fed Seen Tapering QE in $10B Steps in Next Seven Meetings http://t.co/gvmopTBufm Y do economists assume that things follow a simple path? $$ Dec 20, 2013
Fascinating Bernanke can call Fiscal policy restrictive when deficit huge & shrinking a little, doesn’t apply same logic 2 LSAP shrinking $$ Dec 18, 2013
FOMC Central Tendency for Fed funds rate 2013-6 &long-run 0.25%, 0.34%, 1.06%, 2.18%, 3.88% Change 0.00%, -0.06%, -0.19%, -0.09%, -0.04% $$ Dec 18, 2013
FOMC Central Tendency for Fed Tightening — January 2016, 25 months away vs 27 last September, one month further out $$ Dec 18, 2013
FOMC Central Tendency for PCE Inflation 2013-6 & long-run 0.99%,1.52%, 1.79%, 1.87%, 2.00% Change -0.21%, -0.01%, -0.10%, 0.00%, 0.00% $$ Dec 18, 2013
FOMC Central Tendency for Unemployment 2013-6 & long-run 7.05%, 6.45%, 5.91%, 5.53%, 5.54% Change -0.11%, -0.13%, -0.12%, -0.10%, 0.04% $$ Dec 18, 2013
FOMC Central Tendency for real GDP 2013-6 & long-run 2.27%, 2.91%, 3.09%, 2.83%, 2.25% Change 0.14%, 0.00%, -0.07%, -0.05%, -0.09% $$ Dec 18, 2013
Someone ask Ben Bernanke if they would issue fed funds at longer terms/tenors Dec 18, 2013
@AlephBlog wrong again, David — decrease of $10B, $5B each of Treasuries and MBS Dec 18, 2013
@AlephBlog sorry — $5b/month change Dec 18, 2013
RT @NickTimiraos: MBS issuance has plunged since Sept, so a $5 billion taper of MBS doesn’t mean the Fed will decrease its *share* of MBS p? Dec 18, 2013
Statement Regarding Purchases of Treasury Securities &Agency Mortgage-Backed Securities http://t.co/97DNRGXJFQ Pares MBS buys by $10B/mo $$ Dec 18, 2013
An Opiate for Underachievement: Bernanke Says Fed in ?Finest Hours? Stood Up to Pressure http://t.co/soQDjBHZea Rather, they caved & hid $$ Dec 17, 2013
The One Thing Bernanke Must Not Do Tomorrow http://t.co/AvDcElOHTY Saying & not doing loses credibility 4the Fed. Don’t say wut u wont do $$ Dec 17, 2013

Companies & Industries

The Buffett difference, derivatives edition http://t.co/5VUI7WxOUB Soft collateral reqs, tolerated earnings vol, bot in size w/variety $$ Dec 20, 2013
Target Data Breach Has Become a Card Data Fire Sale http://t.co/jUxgOpv7SP B especially wary here because it can b used as a debit card $$ Dec 20, 2013
Buffett’s massive wind-power order shows wind energy becoming cheaper http://t.co/0lOSGp3NQi Wind power becomes economical, end subsidies $$ Dec 20, 2013
Facebook Is Selling Stock For Some Reason http://t.co/x9LsnLUMNb $FB makes it easier 4 index buyers to get shares as it enters the S&P500 $$ Dec 19, 2013
Facebook, Zuckerberg to Sell Stock Worth Nearly $4 Billion http://t.co/B4joZJZYR9 Note $FB compny selling shares; not usually a good sign $$ Dec 19, 2013
Regional Shippers Pose New Threat to UPS, FedEx http://t.co/RNUpcBrL3Y And USPS too. Regionals can get it there the next day $$ $FDX $UPS Dec 19, 2013
AT&T Sells Wireline Assets To Frontier Communications http://t.co/or1n1lWqbD Interesting 2c $T sell off rural wireline customers 2 $FTR $$ Dec 18, 2013
Gold Town Turns to Dust as Metal Decline Shutters Mines http://t.co/unN2Mi97A3 Life at high-cost mines is very cyclical. Boom-bust $$ $GLD Dec 18, 2013
Dodge CVT Animation http://t.co/cfEWG0Y9jQ Cool 82-second video of how a continuously variable transmission works $$ $GM $F $TM $HMC Dec 18, 2013
How Good Old Car Engines Got So Efficient http://t.co/hM5ZmjdXpK Most progress w/energy has come by using hydrocarbons more efficiently $$ Dec 18, 2013
Delta Battles Tiny Upstart Airport http://t.co/HbalfXKYc3 B careful of small airports near big cities, u don’t want 2create the next $LUV $$ Dec 18, 2013
Poor Americans Lead Movement to Abandon Landlines http://t.co/MmUfqiljPa Landlines r dying; I’m thinking of getting rid of mine $$ $SPY $VZ Dec 18, 2013
Pizzerias Try to Apply Chipotle Formula http://t.co/afyCN5xi2u Creating Fast, Custom & Inexpensive 4 pizza; many r trying, who will win? $$ Dec 18, 2013
Campbell Seen as Next Buffett Target Post-Heinz http://t.co/zryODDWpRs Likely wishful thinking; soup shrinking; PE high, no growth $$ $CPB Dec 17, 2013
Wind Power Rivals Coal With $1B Order From Buffett http://t.co/WXJfEAHmrn Wind power gets competitive on price; can we end the subsidies? $$ Dec 17, 2013
Google Just Bought a Mechinized Cheetah and Other Military Robots http://t.co/5ZO3XXzcNF 1st internet search now robotic world domination $$ Dec 17, 2013
Google, Facebook Push to Control Web’s Pipes http://t.co/nmDzeospON Content companies want more control over their delivery over the web $$ Dec 17, 2013

Market Impact

Three things long/short hedge funds cannot do (well) http://t.co/zyiE65FcAZ Manage risk, Short stocks on a systematic basis &stop trading $$ Dec 20, 2013
Investors should abandon long-term commodity bets http://t.co/5rGgYXj5fy End of supercycle, no income, correlated w/equity returns $$ $GLD Dec 20, 2013
DJIA Rises to Inflation-Adjusted Record High http://t.co/nseI2H9eF4 Closes at 16,221. Guess I have 2 eat my words: http://t.co/A6kJoniqG5 $$ Dec 20, 2013
The FOMC- SCR Factors- Bullish SP500? http://t.co/pI3A04XM71 The TINA effect: TINA stands 4 There Is No Alternative.(to Stock investing) $$ Dec 19, 2013
Investor Hunger 4US Corporate Bonds Signals Confidence http://t.co/PsCIMa25A9 Retweet after me:Credit spreads r free $$, credit spreads r… Dec 17, 2013
Want to invest like Buffett? Here?s how http://t.co/3CIqNByFVU Focus on cheap, high-quality stocks w/moats, lever using ins float $$ $BRK-B Dec 17, 2013
Corn Plummeting Spurs Talk of ?80s US Farmland Bust http://t.co/QoO5lVTXSx Will b interesting 2c how many recent buyers get inverted $$ $SPY Dec 17, 2013

Financial Sector

US Credit Markets: US Lite Covenant: Freshness without Protection ? http://t.co/F2HguklHFM Credit protections getting worse 4 bank debt $$ Dec 20, 2013
OCC believes banks might be gambling again http://t.co/lMG9YG24dj The OCC is seeing looser underwriting, reminds them of 2007 $$ #toosevere Dec 20, 2013
Man Who Said No to Soros Builds BlueCrest Into Empire http://t.co/UNksM1mSvl Borrowed $750M to hire 25 equity mgrs 4 his hedge funds $$ $SPY Dec 20, 2013
Secret Currency Traders? Club Devised Biggest Market?s Rates http://t.co/dtBfuqR48w There is no human system that cannot b gamed $$ $SPY Dec 19, 2013
New Mortgages to Get Pricier Next Year http://t.co/oNfGLJeZCC About time F&F raised fees; dodgy mtges have much higher loss rates $$ $FNMA Dec 18, 2013
Volcker Rule Shows Its Wide Reach http://t.co/MOZMjUFoj8 Securitized assets, when they default, most frequently default w/zero recovery $$ Dec 17, 2013
First Volcker Victim? Zions Dumping Its Hedge Funds http://t.co/Kj8uYfltTn $ZION cleans up the trash w/now-sufficient capital $$ Dec 17, 2013

PPACA / Obamacare

Obamacare Initiates Self-Destruction Sequence http://t.co/VkbqqPzMYb @asymmeticinfo asks what will Obama do next year on indiv mandate? $$ Dec 20, 2013
Obama Lifts Health Mandate for Those With Canceled Plans http://t.co/aCYJLzaOZz Must b nice 2b able 2alter laws by presidential fiat $$ Dec 20, 2013
More Obamacare Delays. Surprised? http://t.co/keWUsmLvay @asymmetricinfo thinks the law will survive b/c insurers benefit in long-run $$ Dec 19, 2013
A Medicaid Bet in Wisconsin http://t.co/Ejgbmbd61B Scott Walker Says He Wants to Protect the Poorest; Critics Assail 4Not Taking US Funds $$ Dec 19, 2013
National Lampoon’s ObamaCare Vacation http://t.co/Vzp636uMCW Interesting to hear how poorly Maryland is doing w/its healthcare website $$ Dec 19, 2013
Half of Uninsured Say Health Law Is Bad Idea http://t.co/BEWOeZg1gK When those that u r trying 2 benefit don’t like it, u know it is bad $$ Dec 18, 2013
Is Obamacare Really an Improvement on the Status Quo? http://t.co/Zc1umGhp1l More people lose insurance than gain it; status quo better $$ Dec 18, 2013
Insurers Fight Hospitals’ Paying Premiums for Poor http://t.co/WnuoAo481T Hospitals pay to get sick people insured, so they can make $$ $SPY Dec 17, 2013
Errors Continue 2Plague Government Health Site http://t.co/5j6OZRqkqZ Flaws Include Missing Customers & Erring Eligibility Determinations $$ Dec 14, 2013

Rest of the World

Putin Bets $15B to Capture Junk-Rated Ukraine Vassal http://t.co/vjxhVcT8gv Rebuilding the USSR is tough work for a tough man to do $$ Dec 19, 2013
South Sudan Rebels Take Key Town of Bor http://t.co/MMQumSSIHZ It’s in the center of the country, kind of a crossroads 4 commerce/travel $$ Dec 19, 2013
Vatican Hires Global Firms to Modernize Communications, Accounting http://t.co/1CRwzMDbs8 Humility arrives at the Vatican, expertise 2 $$ Dec 19, 2013
Russian Amnesty Includes Greenpeace as Well as Pussy Riot http://t.co/b8FNVgaQx6 Is Russia getting soft? 😉 Courting international favor $$ Dec 18, 2013
Mom Can?t Visit Daughter as Airlines Shun Venezuela Cash http://t.co/1uds13LW3t Such is life 4those under currency controls; freedom goes $$ Dec 18, 2013
North America to Drown in Oil as Mexico Ends Monopoly http://t.co/5bV35xIc7o Oil is no good to Mexico if can’t get it out of ground $$ #tech Dec 18, 2013
South Sudan Puts Down ‘Attempted Coup’ http://t.co/19KfhoRdVJ A young nation, very experienced in corruption; attempted coup unsurprising $$ Dec 17, 2013

China

China s Stealth Tightening? http://t.co/tuW7JvVhFI A new squeeze hits the China Interbank market & the authorities aren’t doing much $$ $FXI Dec 20, 2013
Why Are the Chinese Scared of American Corn?? http://t.co/lEGbWgh2r4 Probably some Party bigwig who sells domestic corn complaining $$ Dec 19, 2013
Can China Teach North Korea to Grow Up? http://t.co/J6Ba2jpzVz If N Koreans had as much freedom as the Chinese do, Kim would b overthrown $$ Dec 17, 2013
China’s Cities Chop Down Hills for Industrial Land http://t.co/KTpYOwgXNK Wonder what the secondary effect will b from this terraforming? $$ Dec 17, 2013

US Politics & Policy

The Trouble With Populism? It Isn?t That Popular http://t.co/RXSmHLDWTu All sorts of extreme positions, mine included, r never popular $$ Dec 19, 2013
Republicans Block Symbolic Step to Extend Tax Breaks http://t.co/mxUZ31R7GZ Rationality. Maybe temporary tax breaks will b temporary? $$ Dec 19, 2013
Obama?s own panel rips NSA spying on phone calls of Americans http://t.co/QYx1lJXLfc The consensus is that the NSA has gone too far $$ Dec 19, 2013
John Podesta eats crow: ?I apologize to Speaker Boehner? http://t.co/XyCLBNrjWs Don’t blame Podesta, he just drank his own Kool-aid $$ 😉 Dec 19, 2013
At 61 She Lives in Basement While 87-Year-Old Dad Travels http://t.co/KTF0YCOpWx Each generation does successively less well on average $$ Dec 18, 2013
That’s the nature of all of the fixed payment plans devised by the “Greatest Generation.” They borrowed from children & grandchildren $$ Dec 18, 2013
Top Democrats reject court ruling over NSA spying on Americans http://t.co/wnNGQmJwys Interesting 2c varying opinions in both parties $$ Dec 18, 2013
Unmasking the Mortgage Interest Deduction: Who Benefits and by How Much? http://t.co/4PzAbpa7rs Benefits the well-off; end & balance bdgt $$ Dec 18, 2013
Hidden Danger in Public Pension Funds http://t.co/lBgACsI12P Low Funded status, high amounts in risky assets, bonds offer little yield $$ Dec 18, 2013
Disarming Surveillance http://t.co/70nAEtNTJA The opposite danger is that by snooping on others intensively they grow to resent the US $$ Dec 17, 2013
NSA Phone Spying ‘Almost Certainly’ Unconstitutional, Judge Says http://t.co/cnqxDbGXrW Probably won’t b upheld, good 2try overturning $$ Dec 17, 2013
The truth about the NSA’s bogus malware apocalypse http://t.co/nJ3hMCrcwq Most mass attacks r hard 2pull off w/any significant force $$ $TLT Dec 17, 2013
In Bankrupt Detroit, the Bills Are Piling Up http://t.co/eJrX6tgIgO One tough part of a muni b/k – who gets paid & what r reasonable fees $$ Dec 17, 2013
Accidental Tax Break Saves Wealthiest Americans $100B http://t.co/RU6y8vCNZc ?I?ve done a lot4 Democratic contributors,? he sez w/a smile $$ Dec 17, 2013
Look How Easy It Is 2 Game Estate Taxes http://t.co/u3YGvZ491l Y the estate tax needs 2b replaced & income taxes disallow income deferral $$ Dec 17, 2013

US Economics

GDP Grows 4.1% in Third Quarter, Biggest Gain Since 2011 http://t.co/tUCz0bQViw Guess I have to eat more of my words, US looks good 4 now $$ Dec 20, 2013
Boomers as Retail Clerks Shows Y Greenspan Saw Low Growth Era http://t.co/phoiELeks2 Long good article how aging populace changes economy $$ Dec 19, 2013

Other

Finished the #GoogleCrossword http://t.co/VtaoYkaQdt Haven’t done a crossword in years $GOOG #fun Dec 21, 2013
Why Successful CEOs Get Fired http://t.co/KehYfcljKv Founding CEOs get fired when tasks get larger than them, &the board loses confidence $$ Dec 19, 2013
Doctors Eye Cancer Risk in Uterine Procedure http://t.co/CD5OKwWs2I Grinding up fibroid in the uterus may increase the risk of cancer $$ Dec 18, 2013
Top Products in Two Decades of Tech Reviews http://t.co/GQjGsMR1Xz Walter Mossberg’s last column @ WSJ; a joy 2 read, will still b on web $$ Dec 18, 2013
Youthful Migrants Lured by Perks to Shrinking US Areas http://t.co/jxFNa41ftZ Promising idea to create urban jobs in rural areas $$ #winwin Dec 18, 2013
How Dogs Might Protect Kids Against Asthma: Gut Bacteria http://t.co/HaWa0goqdn Fascinating that dogs may aid kids w/immunity to asthma $$ Dec 17, 2013
Multivitamins Found to Have Little Benefit http://t.co/5o8jUZGkYc The controversy will continue; nothing this profitable ever dies $$ $SPY Dec 17, 2013
Vonn Rivals Schuss From Slope to Boardroom for Funding http://t.co/GaJHLVAyob Olympians r little corporations seeking sponsors, donations $$ Dec 17, 2013
Stocks That Still Have Perks http://t.co/k93IaeQlgl From discounts on cars&computers 2cruise bounty, here’s where 2find shareholder perks $$ Dec 14, 2013
The Tsarnaevs and the Boston Bombing http://t.co/Pz8MxYQXEf A decade ago, WSJ reporter happened to befriend the Tsarnaevs- an inside view $$ Dec 14, 2013
Mike Tyson Explores Kierkegaard http://t.co/n2mrAx1KuW Philosophy is a dead end; no truth to their views of existence, knowledge &ethics $$ Dec 14, 2013

Wrong

Wrong: Bernanke: More Financial Reform May Be Needed http://t.co/gxitPtPQxb Dumb

comment from a guy who doesn’t understand how banks work $$ Dec 19, 2013

What Bible is Pope Francis reading? http://t.co/EvnvIDNZlo Jesus never questioned property rights in his teaching, w/charity voluntary $$ Dec 19, 2013
How Pope Francis Misunderstands the Free Market http://t.co/Ksmn5DzS0O Simpler than that; he is unstudied, engages in wishful thinking $$ Dec 18, 2013
Wrong: Technology Adoption Discrepancy Btw Individuals & Institutions http://t.co/YkLJscgP7S Tries 2 connect falling ROA & Social Media $$ Dec 14, 2013

Comments

“Artificially forcing down Treasury yields via QE has 4 major bad effects?” ? David_Merkel http://t.co/z9nLhQSknr $$ $TLT $IEF $SHY Dec 19, 2013
Commented on StockTwits: but the company is selling; it needs cash more than shares — good companies typically s… http://t.co/AkpvtYiijw Dec 19, 2013
Commented on The Economist | Daily chart: Doomsdays http://t.co/21NoGGuzuD Dec 18, 2013
“I analyzed TRUP CDOs 4a bank in 2008 and 2009 — built a special model that could dig into the?” ? David_Merkel http://t.co/tRm5NtJ0mk $$ Dec 17, 2013
Commented on StockTwits: ‘ @MMula534 A lot. Most of the best investors r lifelong learners, & they c patterns whe… http://t.co/5pQzWca6Nm Dec 17, 2013

The Education of an Investment Risk Manager, Part VI

Posted on 29 September 201329 September 2013 by David Merkel

My boss walked in and said that we needed to terminate our annuity reinsurance treaty with an entity that I will call Bigco (this happened in July).? Senior management had deemed that we should do it, and in days we visited Bigco, assuming that the actuary in question would approve a termination of the treaty where:

There was no termination provision.
There was a guaranteed minimum return to the reinsurer.
The reinsurer had participation in the upside of profits.

Who negotiated such a treaty?? Very one-sided, and Bigco needed to deploy capital, not contract it.

Could a negotiating position be worse?? Yes, it could, just wait.

When we got to Bigco, we talked with the actuary for a little while, and then he handed us over to the head of M&A.? Uh-oh, he sized up the situation perfectly, and denied our request, unless we were willing to pay considerably above book value to repatriate the assets.

We went home depressed, and a few months after that my boss was summarily fired.? In those days, September was the firing time.? You can imagine what that did for morale.? Personally, I expect my boss was fired because he was most similar the the CEO, and had done things well in managing his line of business.

One day the chief actuary came to me and said, “We have to terminate that treaty.”? I explained to him the backstory, that we had offered to buy it back at an ROE of 9%, and Bigco was demanding 6%.? I said to him, “I’ve already compromised the 10% ROE objective of our company, I don’t want to go further.? I’m free to walk away, right, if we can’t get a decent price?”? He said, “No, the deal must be done.? Under no circumstances can you walk away.”

The sad thing was that any termination of the treaty would positively affect management bonuses.? (That was the real target.)

I had a strong sense that I should always serve the ultimate owners of the firm — the dividend receiving policyholders.? But this was at variance from that.

So, with the weakest bargaining hand that I can imagine, I used the following strategy.? I did nothing.? Nothing. Nothing until early December, where I called the M&A guy at Bigco and and told him, “I’ve had a change of heart.? I’ll accept an ROE of 6.9%.? That’s my final offer!”? This was ticklish because I *had* to get the deal done.

He bit on the offer, and I pressed him saying that between this time and the closing, my market value adjustment formula would rule.? He agreed.? (He probably had a profit goal as well, which was what I was counting on.)

But, he didn’t look closely at the Market Value Adjustment formula.? I gave him one that was volatility-loving, that would adjust of the greater of the absolute value of the yield changes in 3-month T-bills or 30-year Treasury Bonds.? Don’t criticize the guy too much, the Federal Reserve fell for the same tactic on GICs they bought from us.

Before the deal closed, the Fed started tightening monetary policy, and the Market Value Adjustment got us out at an ROE of 9.1%.? What a win, and for the policyholders.? Management got more as well, and I got almost nothing.

I took risks trying to do the right thing, praying the God would help me, and in this case, it worked.? Can you be more righteous than your management team?? In most cases, no, but in this case I succeeded.

I would say to all, try to serve the interests of owners rather than management.? Act like an owner, not like a manager hauling down a fat salary.

Advice to Two Readers

Posted on 16 February 201317 February 2013 by David Merkel

I have great readers.? Two questions tonight on very different topics:

I’ve really enjoyed reading your blog ever since I came across it (via Simoleon Sense, I think?). I think your perspective as a bond manager is especially neat. When I was doing some research on Sears I?saw something odd in the most recent 10-Q and I was curious to see what you thought about it. It seems like the company sold $250M in bonds to its own pension plan back in 2010:

Senior Secured Notes

In October 2010, we sold $1 billion aggregate principal amount of senior secured notes (the ?Notes?), which bear interest at 6 5/8% per annum and mature on October 15, 2018. Concurrent with the closing of the sale of the Notes, the Company sold $250 million aggregate principal amount of Notes to the Company?s domestic pension plan in a private placement. The Notes are guaranteed by certain subsidiaries of the Company and are secured by a security interest in certain assets consisting primarily of domestic inventory and credit card receivables (the ?Collateral?). The lien that secures the Notes is junior in priority to the lien on such assets that secures obligations under the Domestic Credit Agreement, as well as certain other first priority lien obligations. The Company used the net proceeds of this offering to repay borrowings outstanding under a previous domestic credit agreement on the settlement date and to fund the working capital requirements of our retail businesses, capital expenditures and for general corporate purposes. The indenture under which the Notes were issued contains restrictive covenants that, among other things, (1) limit the ability of the Company and certain of its domestic subsidiaries to create liens and enter into sale and leaseback transactions and (2) limit the ability of the Company to consolidate with or merge into, or sell other than for cash or lease all or substantially all of its assets to, another person. The indenture also provides for certain events of default, which, if any were to occur, would permit or require the principal and accrued and unpaid interest on all the then outstanding notes to be due and payable immediately. Generally, the Company is required to offer to repurchase all outstanding Notes at a purchase price equal to 101% of the principal amount if the borrowing base (as calculated pursuant to the indenture) falls below the principal value of the notes plus any other indebtedness for borrowed money that is secured by liens on the Collateral for two consecutive quarters or upon the occurrence of certain change of control triggering events. The Company may call the Notes at a premium based on the ?Treasury Rate? as defined in the indenture, plus 50 basis points. On September 6, 2011, we completed our offer to exchange the Notes held by nonaffiliates for a new issue of substantially identical notes registered under the Securities Act of 1933, as amended.

I feel like that’s a bit odd, but I couldn’t find much about it either way. I assume you’ve pretty much seen it all with bond placement, so I figured you’d be a good person to ask – is that normal? Or is that something you see when a company has a hard time finding buyers for its debt? My gut says the latter since you’re basically jacking up your pension fund’s exposure to the company’s health and creating some agency issues, but maybe that’s just naivete on my part…

Anyway, love your blog, you’re putting something great out there (and not too many folks can say the same).

Aye, Miguel Barbosa, I know him.? We had dinner together in Chicago 1.5 years ago.? A great guy.

As for the odd Sears bonds, often companies with liquidity difficulties take the desperate step of issuing company securities to the pension plan.? You will note that most of the demand for the bonds came from external parties, and then they used that price to issue another $250 million to the pension plan.? To be perfectly above board, if I had been doing it, I would have done the deal for $1.25B, with a protected $250M order from the pension plan.? External investors should know the total size of the deal.

I’m not a pension actuary, but I do know that there are limits on what can be bought by pension plans of affiliated securities.? It is not considered to be a good practice — it is a form of leverage, and good companies don’t do it.? It would make me more skittish on Sears from a credit perspective.? Doing this is a red flag.

Aside from that, Eddie Lampert has harmed the interests of bondholders before, when he bought KMart.? Why should you be docile for someone who does not respect bondholders?

Here’s email #2:

I know you’re a big fan of RGA. How do you get comfortable with the tail risk potential from pandemics? What would downside be for the stock in the event of a pandemic?

I look forward to hearing your input.

That’s a good question.? In late 2004, I attended the Casualty Actuarial Society Annual Meeting in Montreal.? That was the first time I heard about H1N1, and the threat it might pose.? I owned for clients two pure-play life reinsurers at the time, RGA and (spit, spit) Scottish Re, so the potential problem concerned me.? After a lot of research, I held onto my reinsurers, here’s why:

Positives:

People are a lot healthier now than in 1918
We are better at screening visitors from areas where avian flu exists.
The 1918 virus was unusual in terms of its ability to spread to humans and its virulence
Fewer people sleep on the ground with the birds that they shepherd.
Chickens and pigs are usually more separated now than previously.
Also humans don’t have as much contact with pigs.? Confinement raising may be cruel to animals, but it protects human health, in addition to being economic.

Negatives

No one alive has any immunities to the avian flu.
Flu shots and Tamiflu are worthless with respect to the avian flu.? Don’t get vaccinated.? It is close to useless.? I have never gotten vaccinated.? They can’t predict what strains will be virulent six months in advance.

Now, nothing is impossible.? There is risk here, just as there is risk of large meteorites hitting earth every 100 years or so.? Those are risks I have to live with, unless I have special information, which I don’t.

More disasters don’t happen than do happen.? As Ecclesiastes 11:3-6 says:

If the clouds are full of rain, They empty themselves upon the earth;
And if a tree falls to the south or the north, In the place where the tree falls, there it shall lie.
He who observes the wind will not sow, And he who regards the clouds will not reap.

As you do not know what is the way of the wind, Or how the bones grow in the womb of her who is with child,
So you do not know the works of God who makes everything.

In the morning sow your seed, And in the evening do not withhold your hand; For you do not know which will prosper, Either this or that, Or whether both alike will be good.

Worrying about large disasters is fruitless.? Far better to try to be productive, than to try to time disasters.? Productivity is something we can control under ordinary circumstances.? Disasters are something we are subject to, and are very hard to avoid, so unless you are one of the favored ones with inside knowledge, aim to be productive? — it is the far better choice.

Full disclosure: Long RGA (double-weight)