Foreclosure Update

I know that I am probably the last one to write a post on this, but I have been trying (unsuccessfully) to reconcile some data in the RealtyTrac report. A few things from the month to month reports do not tie out with their quarterly figures. Anyway, the numbers are still grim: well over 300,000 new foreclosure notice in March. What I find astonishing is the rate of home foreclosures in certain states for the first quarter of this year.

- Florida 1 in every 73 homes received a notice

- California 1 in every 58

- Arizona 1 in every 54

- Nevada 1 IN EVERY 27

Weekly Jobless Report

Initial claims dropped last week to 610,000. Of course, the previous week was revised higher. Continuing claims continue to jump higher, eclipsing 6,000,000 for the first time (data goes back to 1967).

All We Need to Know: Real Interest Rates

The Fisher Equation:

nominal interest rate = inflation rate + real interest rate + (real interest rate * inflation rate)

The last term is typically small and ignored when casually calculating the real interest rate. So:

real interest rate = nominal interest rate - inflation rate

This is important because the net impact of borrowing can only be calculated with this rate. For example, a consumer borrows $100 for 1 year at 6% simple interest. With the $100, the consumer buys a year's worth of groceries. In one year, the consumer needs to pay back a total of $106.

Let's say that over that year, prices were steadily increasing. If the consumer bought groceries over the course of the year, the average price would have been $110. The consumer benefited from borrowing and locking in prices at the beginning of the period.

In equation form: -4% = 6% - 10%

With regard to businesses, they will borrow money to produce goods if they can sell those goods at higher prices in the future. There is a production lag, of course. Goods that are being manufactured today usually aren't sold today.

Companies need more pricing power when interest rates are higher. As we know, corporate credit is terribly expensive. Today's CPI release shows us that they do not have the requisite pricing power to borrow at current rates. This is the danger of deflation. Why would a consumer borrow money to lock in prices if prices are going to fall? Why would a business borrow money to produce goods that will drop in price? No demand for debt........

Yet, real interest rates are not low by recent historical standards. The graph below tracks a bank lending rate (nominal proxy) versus an inflation rate (CPI). The government if failing miserably at creating an environment that will promote growth. THEY NEED TO STOP BEFORE THEY INSURE A DEPRESSION FOLLOWS. Let the savings rate rebound and suffer the pain of inventory and consumption correction. Issuing debt is only increasing real interest rates and cutting the recovery off at its knees.

Is a Depression Upon Us?

The BLS released the monthly CPI report today: 0.1% drop from February.

This brings the year over year drop to 0.4%, the largest annual decrease since 1955. The above graph goes back to the early 1970s and it is easy to pick out the recent trend. Although PPI has, from time to time, breached the zero barrier, CPI has not. Deflation is upon us.

Going back to Irving Fisher's piece, "The Debt-Deflation Theory of Great Depressions", the pairing of overindebtedness and deflation leads to depressions. I think the case for too much debt is clear:

- Federal debt to GDP ratio is at a generational high

- Homeowners now face negative equity

- Corporate borrowing spreads at multi-year highs

Fisher came to the conclusion that, if acted upon soon enough, the government can reflate the economy. I do not believe that this is the case today. He may have been writing with a different monetary/banking system frame of reference, the Fed was still brand new at the time. But as I have mentioned, debt is money in our world. The paradox will prohibit reflation from happening. We are staring into the abyss.

Link to Fisher paper:

http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

China Has Fewer USD to Spend As Well

In a post last week I mentioned the deteriorating current account surplus of Japan and its impact on our national debt. Consider the following:

China Slows Purchases of U.S. and Other Bonds

http://www.nytimes.com/2009/04/13/business/global/13yuan.html?_r=1&ref=business

I tried to find the data myself, but the People's Bank of China website is terrible. Suffice it to say, with fewer buyers of Treasury debt, something has to give.

A Closer Look at Goldman Sachs' Earnings

As you know, The Goldman Sachs Group, Incorporated became a bank holding company last year. As such, they became eligible to participate in the government rescue programs. They expanded their bank operation so they could foist the bulk of their assets on the back of the FDIC. Check the FDIC website, the assets of Goldman Sachs Bank USA have grown from $19.1 billion to $162.5 billion in just one year. Funding with deposits is much cheaper than funding with corporate debt.

Anyway, as a bank holding company, they are required to report earnings on a calendar year basis. They had formerly reported using a November fiscal year end. Their most recent annual report includes financials up to NOVEMBER 30, 2008.

Last night's release included the earnings for January, February and March of this year. Goldman reported earnings of $3.39 per share, easily besting estimates of $1.64 per share.

You may ask, what happened to December? It was not included in the previous quarter's release, nor in this release. Well, December appears at the end of the press release in its own little category.

What happened in December? I'm glad you asked. Goldman recorded a LOSS OF $2.15 per share. Add it together, and you come up with earnings of $1.24 for the four month total. I am not sure about how Wall Street analysts accounted for this, but it adds up to an earnings miss to me.

I have attached the link below, please double check my understanding of the data. I would hate to bad mouth Goldman.

http://www2.goldmansachs.com/our-firm/press/press-releases/current/pdfs/2009-q1-earnings.pdf

Looking at CDS.....Again

This may be getting a bit boring, but I want this point driven home: asset prices are not recovering. Bank stocks are moving higher (we'll get to that in another post), but it is not because the market perceives asset quality to be improving.



Two tranches closed at record lows today. Every tranche is trading within 9.2% of its lowest closing level. I really don't expect the BBB- CDS to move much, but the single A and higher tranches are not budging either.




Twenty-eight CMBX tranches closed at new highs today. The only ones trading markedly off their highs are the AAA tranches. Not coincidentally, these tranches represent the types of securities eligible for purchase by the asset purchase programs.

Please review the posts from 11/18/08, 2/24/09, 3/28/09 and 4/8/09 for more details.

Retail Sales

The Census Bureau released its monthly retail sales report today: 1.2% drop from February.

Obviously, the consumer is sitting this "recovery" out. All of the work the Administration is doing to promote consumption is for naught. It is the wrong premise anyway, rebuilding savings is the way to go. As painful as it will be, it is the only fix.

Full year 2008 retail sales actually decreased from the full year of 2007 and the slowdown shows no signs of letting up. Retail sales for the 1st quarter of 2008 totaled $1.14 trillion. For the 1st quarter of this year, the total is $1.04 trillion. This is a drop of about 8.75%, a number that prompted retail stocks to sell off substantially today.

Banner Day for Financial Stocks

- Can we trust the government to be objective when they are the major shareholders in banks?

- How "stressful" were the stress tests?

- How much will the modified accounting rules add to earnings?

- Is writing up asset valuations really prudent when continuing unemployment claims are just about 6 million?

- Do you think that most of the banks' operating earnings resulted from the MBS land grab?

I got what I wanted, an unwarranted rally in bank stocks. Prepare to short the sector en masse. Watch out for SEC rule changes on the way. The government is out of bullets.

Pension Benefit Guaranty Corporation (PBGC)

With the discussions of a GM bankruptcy heating up, the press has turned to an examination of the GM pension plan. According to a Bloomberg article, the PBGC would be on the hook for about $4 billion of the $20 billion plan short-fall. GM workers would take a $16 billion hit.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aazS4bEfFmzs


So I took a look at the books of the PBGC. Amazingly, they are ALREADY operating at a deficit. As of 9/2008, the PBGC has a negative net worth of $11.15 billion. They have a $100 million credit line with the Treasury. Any material borrowing to cover deficits will be on the back of the taxpayer via debt issuance. Sound familiar? FDIC, NCUA and PBGC: the taxpayer covers for corporate malfeasance and regulatory incompetence.

ASSET-BACKED CDS TRADES AT NEW ALL TIME EXTREMES

How is this for an unambiguous snapshot of the asset backed market:

- 28 of the 34 CMBX tranches closed at new all time highs today

- 12 of the 24 ABX tranches closed at new all time lows today

NOBODY WANTS TO OWN THIS PAPER !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Please check posts of 11/18/08, 2/24/09 and 3/28/09 for details about the CDS markets.

Merger in the Home Industry

Pulte Homes to Buy Centex for $1.3 Billion in Survival Bid
http://www.bloomberg.com/apps/news?pid=20601087&sid=acFiZhbx1OZM&refer=home


This is the first real sign of a bottom that I have seen. I know, it is a relatively small trade because Centex stock is down 70%. But two companies were able to agree on a future valuation for home building. They could be right, they could be wrong. What is important is that the process has begun.

Forget all of the other false positives, here is your green shoot.

New Data From Japan: Who Will Buy U.S. Debt?

The current account is the sum of the balance of payments, financing activity and financial transfers for a nation. For a nation like Japan:

- Exporting nation, balance of payments positive

- Net creditor, financing positive

- Established nation, transfers negative

Net, Japan typically reports a monthly positive current account. That means that they have to figure out what to do with the foreign currencies they receive. The U.S. has been a major importer of Japanese goods, so they usually have a large supply of USD on hand. If Japan always sells those USD and buys JPY, they would erode their competitive advantage. They want a cheap JPY, so they keep the funds in USD and buy U.S. Treasuries.

This has provided the U.S. with a stable demand for debt. There are two major problems though: Economic slowdown and the emergence of China.

China has now eclipsed the U.S. as Japan's top trading partner. It is a sign that our political clout will wane and shows how much we are falling on a relative trade basis. Our nation is in a DEPRESSION and China is growing (albeit at a slower rate than the last five years).

The U.S. imports from China, meaning that they have a large supply if USD as well. However, our economy is slowing so much, that the growth rate of their USD position is falling as well.

U.S. Treasuries have been in the news because of the large supply being issued to fund all of the new government initiatives. Some say you should sell Treasuries because inflation is just around the corner. In theory, I agree. The timing is uncertain though. What I do know is that funds available to buy these bonds are drying up and the perception around the world about the soundness of our economy is changing. Get ready to short Treasuries because of that.


China Becomes Japan's Largest Trading Partner
http://www.thetrumpet.com/?q=5446.3771.0.0


Japan Exports Fall to Record Low
http://edition.cnn.com/2009/BUSINESS/03/25/japan.exports/


Export Slump Hits Japan's Current Account
http://www.google.com/hostednews/afp/article/ALeqM5htd2R1bv6caNjG3QVfdGBZU_pIsQ

If You Keep Changing the Rules, Are They Really Rules?

http://www.cnbc.com/id/30083434

SEC is considering ways to limit short selling.

http://www.cnbc.com/id/30090718

Treasury Department delays stress test results to avoid complicating earnings season.

Come on already, we have seen this before and it does not work.

Primary Dealer Holdings ReDux

Please refer to the 2/11/09 post for details about dealer hedging procedures.

Wow, primary dealers are now outright long Treasury securities. No interest rate hedging for these guys, they have perfect information about the future I guess. Let's examine the changing risk appetite over the last nine months:

Corporate Holdings (>1 year): -54.82%

Mortgage Backed Holdings: -14.49%

GSE Debt (>1 year): -35.77%

Treasuries: went from a short position of $69 billion to a long position of $20 billion

The takeaway: dealers are trading credit risk for interest rate risk.