Saturday, January 30, 2010

Public Pensions Peril

It really is amazing to see how very little that so-called professional money managers have learned from the financial markets meltdown and the subsequent multi-trillion bailouts. They are still investing as if nothing happened.

Prime examples of this are the managers who run public pension funds for various states, cities, etc. around the country. To see the managers responsible for the pensions of hundreds of thousands of people across the nation attempt to "secure" the future retirement income of these people by increasing their risk is mind-boggling.

One lesson that should be clear to everyone about the financial markets meltdown was that a large part of the problem was too much leverage. In other words, too much debt...borrowing money to invest.

Yet a Wall Street Journal article this week discussed how many public pension funds (they spoke about the state of Wisconsin) are, you guessed it - deciding to use to use leverage and borrow money to invest in an attempt to increase the return on their pension fund.

When I think of the people who run these public pension funds, words come to mind like stupid, incompetent, naive, gullible.....

The Wall Street "consultants" and salespeople are at the ready to offer their latest and greatest "can't miss" strategies to these fools and they seem to have bought the Wall Street sales pitch entirely.

This latest "can't miss" strategy" involves borrowing money to purchase guess what asset? The asset that I have been warning everyone is in a bubble and a bubble that will explode like a supernova, wiping out everyone unlucky enough to be in its path - long-term US Treasury bonds.

When Treasury bonds blow up in their face, the losses will be enormous because these "professional" money managers used debt (leverage) to give them even more exposure to these bonds.

And who will be left holding the bag? Why taxpayers, of course. They will have to bail out the pension plans of public employees in their local state or municipality or whatever.

What should public pension fund managers do? First, get out of these "recommended" Wall Street positions. They are a ticking time bomb.

Second, tell the people who will be receiving these pensions that whatever promises were made (10% a year or whatever), they are totally unrealistic in the current economic environment. Tell them the truth - that the returns of the 1990s and early 2000s were a once-in-a-lifetime bubble brought about by irresponsible Federal Reserve policies and that we will not see these type of returns any time soon. Tell the pension recipients to lower their expectations.
Of course, the only things that will happen are bailouts of public pensions across the country.

Saturday, January 23, 2010

Yes We Can...Reform Wall Street

It looks like the long overdue correction in stock prices is here. The Dow Jones Industrial Average dropped about 5 per cent in the past three trading days. The stock market has been overvalued for many months, why has it begun falling now?

That can be answered by the wailing and gnashing of teeth you hear emanating from the casino owners on Wall Street. The bankers are upset that President Obama may actually do something to limit the gambling casinos run amok that are known as "banks".

Saying that "never again will the American taxpayer be held hostage by a bank that is too big to fail," President Obama has proposed for banks to be banned from trading on their own accounts and from "owning, investing in or sponsoring" hedge funds and private equity groups.

The most egregious examples of trading on their own behalf comes from Goldman Sachs, who not only routinely frontruns orders from clients, but who was heavily betting against subprime mortgage products which they aggressively sold around the world to clients as highest-quality "AAA" products.

It looks like President Obama is finally taking advice from the only 'adult' among his team of economic advisors - octogenarian former Federal Reserve chairman Paul Volcker. He has been an increasingly vocal critic of the administration's proposed banking reforms, which were no reforms at all. It looks like President Obama has finally invoked the 'Volcker rule' in dealing with Wall Street banks.

Mr. Volcker raised interest rates to unheard of levels to combat the very high inflation levels of the 1970s and early 1980s. Yes, it was painful medicine. But it was necessary. After inflation was crushed, the nation enjoyed years of solid economic growth and a strong US dollar.

I am pleased to see President Obama take advice from someone who has an intricate understanding of financial markets, but who does not kowtow to Wall Street's every wish, unlike his other economic advisors.

Look at Treasury secretary Tim Geithner, who while head of the New York Federal Reserve - which is supposed to oversee Wall Street - four times forced troubled insurer AIG to NOT disclose details of how certain parties (Goldman Sachs) received 100 cents on the dollar for derivative contracts when they should have gotten next to nothing. Why did Mr. Geithner not want those details disclosed to the public who was footing the bill?

Hopefully, Mr. Geithner is on his way out, along with Federal Reserve chairman Ben Bernanke who may not be re-confirmed as Fed chairman by the US Senate. As discussed in prior articles, Mr. Bernanke has given Wall Street untold billions of free money at zero per cent. Where is the zero per cent money for the rest of us?

Of course, the big question is whether any true reform, ala the 1930s, will actually happen. After all, reform measures must pass through Congress where both parties seem to have been bought and paid for by Wall Street.

I believe what we need to see is each of the big banks being 'separated' into two distinct entities. The first would be a 'utility' - a basic, simple bank (like in the old days) which takes deposits, make loans locally to consumers and small businesses. This 'utility' should be backed fully by the US government.

The second entity would be the 'casino' portion of these large banks. Let the traders and gamblers do what they want - if they win, they win, but if they lose, they lose. Absolutely NO government support! And limits should be placed on the leverage they use - back to the 'old' leverage ratio of 10-1, not the crazy 50 or 100 to 1 they used to get into such deep trouble in the first place.

The only hope for real reform of our financial industry may be if enough 'regular citizens' raise heck with their Congressperson. Politicians love one thing more than money and that is power, so they will do anything - even the right thing - to get re-elected.

Saturday, January 16, 2010

The Federal Reserve's Failure to Learn and Its Consequences

In a speech given January 3, 2010, Ben Bernanke placed the blame for the financial crisis on everything from lax regulation to poor peasants in China.

Yet, the 2009 Time Person of the Year refused to look in the mirror and accept the fact that much of the blame for the financial crisis lies with the Federal Reserve and its low interest rate policies.

This bodes ill not only for the future course of monetary policy in the United States, but also does not bode well for the future of the US economy. It's simple - one cannot fix what is broken until there is a full understanding, by those in power, of what went wrong and how.

What Ben Bernanke seems to conviently be ignoring is the impact that ultra-low interest rates had, and continue to have, on the investment world - particularly the effect low rates has on Wall Street's bond managers, including large pension funds, retirement plans and trusts.

Interest rates of zero or one per cent produced an enormous cascading effect on the demand for high-yielding instruments. The details of the effect that low interest rates had was laid out beautifully by Barry Ritholtz, the author of Bailout Nation, at his blog.

I won't go into all of the details, but here some of the important points:

1) Ultra-low yields led to a scramble by fund managers for higher yields;

2) At the same time, there was a massive push into subprime lending by unregulated nonbanks whose sole purpose was to sell these mortgages to Wall Street firms that securitized them;

3) Since these nonbanks did not hold these mortgages for long, they lowered their lending standards to where almost everyone qualified;

4) Massive ratings FRAUD by the ratings agencies led to this junk being rated as Triple AAA;

5) That high investment grade allowed bond managers to purchase this junk which they normally would not have;

6) High leverage allowed a huge securitization process, then more leverage was piled on by the non-regulated derivatives market. This allowed firms like AIG to write $3 trillion in derivative exposure!

7) Compensation in the financial sector was asymmetrical, where employees had all of the upside and shareholders/taxpayers had all of the downside. This led to increasingly risky activity, which continues to this day.

You may say - who cares, it's water under the bridge. But the problem is that the consequences of the financial crisis continue to this day to effect the United States and its citizens in their daily lives.

In order to bail out Wall Street, the government has gone trillions of dollars deeper into debt, with that debt growing exponentially every day.

So far, the Federal Reserve has had their printing presses running full speed day and night in order to have enough money to purchase all of the government debt - Treasuries - to keep the country running.

But that game can only go on for so long before an already weak and declining US dollar goes into a steep dive into oblivion and economic chaos for the American public.

So the federal government has to come up with another solution...finding another pot of money somewhere.

Leave it to our elected officials - they have.

The Treasury Department is looking at ways to FORCE a large portion of ALL retirement plans into "fixed payment annuities" other words, the money would be forced into long-term Treasury bonds.

Officially this is about "retirement security", which sounds nice, but in effect it will be a seizure of private assets in order to fund government deficits at negligible interest rates.

And remember my prior warning - the value of these bonds has only one way to go - down. So the government is thinking about forcing its citizens into a guaranteed losing investment in order to fund the bailout of Wall Street and other privileged elites. Amazing!

Saturday, January 9, 2010

Bond Market Warning

It looks like I am not the only person to be worried about the bond market - specifically the US Treasury market.

Earlier this week, the most successful bond manager of all time - Bill Gross of Pimco - warned about the US Treasury market. This is very important since Pimco has $940 billion under management.

Mr. Gross cut his exposure to US (and UK too) government bonds amid fears that rising government debt could scupper the incipient economic recovery. He fears a big rise in government bond yields, or interest rates, triggered by growing market concerns about US government finances.

Pimco points to the trllions of dollars, literally, in government bond supplies that the United States will be attempting to sell over the next few years. Who will buy this incredible amount of debt?

And Mr. Gross is not alone. Other large fund managers such as Blackrock have warned of the danger of a US government bond market selloff.

The danger I see is that the little guy - the individual investor - has poured money into bond funds at just the wrong time. Flows into bond funds are at an ALL-TIME peak! The main reason for this I believe is their perceived 'safety'.

For everyone who has invested into US government bond funds - they are NOT safe! You can, and at these valuation levels, you will most likely lose money.

Interest rates are near all-time lows, with short-term interest rates near zero. They cannot go any lower than zero...interest rates have only one direction to go - up.

And when interest rates move up, the value of bonds that you hold goes down - you lose money.

I firmly believe that the US Treasury market is the biggest bubble I have seen in all my years of experience in the financial markets. And ALL bubbles, whether it is internet stocks or housing or US Treasuries, eventually burst and the people invested in them get burned.

And like all bubbles, this bubble is based on a myth. Myths like - companies don't need earnings or housing Always goes up.

The myth here is the one called deflation, the scary 'monster' from the 1930s. If we have deflation - prices, earnings and economic activity falling - the only 'safe' investment will be US Treasuries. Thus we have people running for 'safety' and we get 0% Treasury bills.

Even since the financial crisis began, Wall Street economists have warned that deflation loomed and that government policymakers have to take 'bold' action.

Therefore we have the Federal Reserve printing trillions of dollars out of thin air and the US government going trillions of dollars deeper into debt.

The fact that these deeply irresponsible fiscal and monetary policies have funded the "bailout" of the Wall Street banks employing these economists who have spread this deflationary myth is, of course, just a complete coincidence!

Deflation is just a myth conjured up by Wall Street to justify policies that have foisted their losses onto taxpayers, both today's and tomorrow's...and it has succeeded in blowing another financial bubble.

Investors - take the advice of Bill Gross and at the least, lighten your exposure to this financial bubble.

Saturday, January 2, 2010

Investment Predictions for 2010

It's that of the year again when everyone looks forward optimistically to a brand new year. And it's also the time of year when you hear all sorts of predictions for the new year.

As I did last year, I will share a few of my thoughts about the upcoming year in the financial markets. But first, I will look back at what surprised me most about 2009.

I was correct that emerging markets and commodities and corporate bonds would be outperformers for the year, but I am absolutely shocked at the size and length of the upward moves in 2009 for most financial assets.

And the rally in the US stock market and other financial markets is still going strong. Why?

It comes down to the shocking (to me) decision in March by the Federal Reserve to not only lower interest rates to near zero but to adopt quantitative easing. In layman's terms, to print trillions of dollars out of thin air...and sadly, most of this money went directly to Wall Street where they used this money to speculate in all types of markets. And why not - it's 'free' money!

Since the Federal Reserve chose this route, the US dollar has dropped in value by more than 15 per cent and by about 20 per cent on an annualized basis.....

I never thought Ben Bernanke and President Obama would choose this route of devaluing the dollar and lowering Americans standard of living as a 'bailout' for Wall Street, but I was wrong.....

They have and I expect those policies to remain in place for as long as they can get away with it.

Their hand will be forced by either Americans bitching that they don't like having the dollar lose 20 per cent of its value per year which is unlikely, since most Americans aren't even aware of it.....

Or if their hand is forced by our overseas creditors, such as China, which is much more likely. A recent example of this was India's decision to sell $6.7 billion of US Treasuies and to purchase gold with that money.

But enough about 2009, what will happen in 2010?

The obvious answer is that no one knows, but here is my two cents worth.....

GOVERNMENT BONDS - It is ok to park your short-term money into short-term US Treasury bills, but I urge ALL investors to avoid any longer-term US Treasuries. Thanks to the Federal Reserve's money printing, this is the biggest bubble in financial markets history...when it bursts it will be hell for anyone who owns these bonds, such as the Wall Street banks (again) and those people who have rushed into the 'safety' of bond mutual funds this year. The Treasury bubble may not burst for years - who knows - but why take the chance.

OTHER BONDS - I do continue to like other bonds, such as corporate bonds of strong multinational companies. Another area I like for the long-term are bonds of emerging market countries which have billions or even trillions of dollars in reserves, unlike the United States.

CURRENCIES - I expect to see a solid short-term countertrend rally in the US dollar before it resumes its downward spiral. The currencies I like for the longer-term are those of the major emerging countries like Brazil and China and also the currencies of country that have and produce lots of natural resources like Canada and Australia.

COMMODITIES - I continue to urge people to add gold to their portfolio as an 'insurance policy'. I do expect commodities to seesaw higher, propelled by a lower US dollar, increasing demand for commodities from emerging markets and most importantly - diminishing production.

Most people are unaware that the production of many commodities is dropping...even sugar and cocoa are at multi-decade highs because of lower production. And to bring a major project online, be it either a mine or an oil field, takes 5 to 7 years.

STOCK MARKETS - I do expect to see a large correction in ALL global stock markets fairly soon. With that being said, I still favor the emerging markets for the long-term. The future of the global economy lies with these nations - this is where most of the economic growth will come from. Of course, many American companies can and will participate in that growth.

I continue to favor sectors that benefit from the growth in the emerging markets such as commodity and industrial companies, and other sectors such as consumer goods and pharmaceuticals.

The only sectors I strong dislike are the US financial sector - who still have perhaps trillions in bad loans still 'hidden' and papered over by government support - and some of the tech stocks. The recent action in Apple, for instance, strongly reminds me of the action before the tech stock bubble burst in 2000.

That's my two cents worth - I hope everyone has a happy and prosperous new year!