Schizophrenia, that sums up

Here we are in a New Year and as is tradition we see countless forecasts for what will transpire this year. My personal feeling is that they are all worthless since no one knows what the Fed is going to do and there is no denying that the Fed and the Fed alone has total control over the markets. Without the Fed we would not have seen positive returns in 2010, IMHO, and we only got those returns because the central bank flooded the market with extraordinary liquidity, again. The irony is that everyone knows something isn’t quite right, but they seemingly cannot put their finger on what is not normal.

As the weekly headlines come and go they are almost humorous now and completely contradict previous headlines. It is this that is contributing to that unsettling feeling most people have but cannot identify right now. Any given day you read about the recovery, often from a heavily seasonally adjusted figure, which signals a recovery in the economy, even though the unseasonal adjusted figure shows the data is not so hot, and everyone is bullish again. The next week we get a data point that is horrible and the world is coming to an end. Perhaps this is what many economists mean when they say this is a ‘muddle through economy.’ Regardless, things are better there is little question about that, but I would say we have stabilized ourselves in a less bad environment versus a real economic recovery.

I had previously said stocks would move higher and they did, but that is only because of the liquidity the Fed bestowed upon us and not because of truly better data points. We have seen unprecedented stimulus over the past 3 years from the federal government and the Federal Reserve which explains pretty much any positive data point. When you examine the real economy, i.e. Walmart, it is a different story. Frankly, when Walmart which has the largest customer base in the US is struggling when so many are preaching the resilient consumer something isn’t right. I know the high end retailers are doing OK and that proves my point which I made about a year ago that the recovery, thanks to the bailouts, and I use that term loosely, was lopsided to only the wealthy and not to Joe Six Pack.

This is also reflected in the unemployment figures and pretty much anywhere else you want to look. The rich are doing just fine thank you very much, but if you are in the middle class or poor the SNAP program is this way. While this is not fair it simply is what it is and is not going to change anytime soon, sorry. Perhaps that is what scares me the most right now, the inequality of wealth in America, don’t get me wrong I am a capitalist through and through, but it doesn’t take a rocket scientist to read history and what happens when the wealth gap gets this wide. On top of the middle class and poor becoming poorer we are now seeing what I thought was going to happen, inflation without an increase in money velocity.

Those who thought it was impossible for a country to experience inflation without money being in the hands of the people, well, you were wrong. When the central bank plays games, untested games, like QE it hurts the currency which drives up currency sensitive items, food and energy. When prices rise and wages stay the same it will more than likely exacerbate the underlying problems we are suffering from and may lead to civil unrest. We have food prices at the highest level ever and oil about to burst through $100/barrel, where is the outrage from the media on this, and people already feel poor, not a good combination. Again, all of that without an increase in money velocity, go figure.

Now, there are other reasons for the rise in commodities, but they are irrelevant in my opinion since Joe Blow could care less about why prices are rising he just cares about being able to feed his family. What is frustrating to Joe is that he is being told how great things are when he feels poor, is probably going to lose his house, can barely afford food, gas or his power bill. Joe is wondering what planet the commentators on CNBC are from when it is plain as day that things are not right in the real world. What Joe doesn’t understand is that the ivory tower announcers and the Fed are looking at the core CPI which says everything is hunky dory. The question is, do you think Joe cares that deflation is occurring in LED TV’s as much as Ben Bernanke does? Of course not because Joe looks at food and energy, but all economists look at is core CPI which excludes food and energy. That is where the disconnect is coming from, partly.

The public is slowly starting to not believe what they are being told anymore and that is a good thing. Remember how we were told that retail sales were going to be fantastic? They did not look so hot today, except for some high end retailers I might add. What I am getting at is simple, the real economy is catching up with the market. The really sick part is that when the economy does improve the Fed will have to kill the liquidity which will crush stocks. Those that preach stocks are a win-win because the Fed will pump money when the data is bad which is good for stocks or when the economy improves stocks should go higher are wrong, pure and simple.

This is the largest liquidity driven rally in the history of mankind or what TVland would call a bubble. Stocks are expensive and only going higher because of the Fed. However, when the Fed stops feeding free money to the banks it will end, badly. You can disagree with me all you want, that is what makes a market, but you know it is true. This is not a win-win situation for stocks. How can it be when just 6 months ago when liquidity was drying up the market tanked? We only saw a rebound when Ben spoke at Jackson Hole and said he would print and then he followed through, that is not the sign of a healthy market.

What we have is still a whole lot of uncertainty going on in the whole world. Nothing is certain except that central banks will merely print us into oblivion. Europe is a mess, we have some countries wishing to slow down fund flows to them, Korea’s on the brink of war, again, China is not buying UST’s like they once did, the US is awash in debt, which will not be solved by the Republicans, rising prices for food and oil about to go ballistic again. All that stuff is off the top of my head and I know I left a ton of stuff out, but this is enough, hopefully, to make one stop and think.

I said before that stocks will move higher and I continue that thought until one of two things happen, either the data really does improve or until QE2 ends in 2Q11. Both items are basically indications that the punch bowl or liquidity will dry up. I also believe stocks will underperform commodities, specifically silver and copper, in 2011 simply because the Fed will never stop the printing presses, they cannot. We are in a very odd period of time and, frankly, these are scary times with so many unknowns out there and a public slowly waking up to the fact that things are not as they seem, but that is a good thing, IMHO.

2011 will be a rollercoaster year with the schizophrenia kicking into high gear as far as the media is concerned, the world will be growing or coming to an end every other day, which should add more volatility to stocks. I also think we will see some things come to the forefront of discussion this year. How it ends is anyone’s guess and I will not even venture agues at the results. What I do know is that it probably will not be good. Here are my issues I think will be front page news this year:

-          Food prices continue to rise to scary levels

-          Treasuries begin to see a steep selloff

-          The US’s national debt will be a hot issue with China downgrading us, rightfully so, to junk level

-          The US is put on negative ratings watch by Fitch, but who cares about Fitch… right?

-          The tax cut extensions will prove to be a horrible idea, they really were to begin with

-          The Social Security tax break everyone gets moves up the date of depletion of the trust fund to, “officially,” the 2020 decade

-          Oil breaks through $100 probably eclipsing 2008 record price

-          The dollar will rally hard before it falls

-          Food shortages around the world will be a major problem

-          The Fed looses massive amounts of money on their treasury holdings

-          China openly sells US treasuries

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Another $100 – $150 billion needed?

The US banking system is still a mess no matter what the regulators and pundits say. From the Volker Rule to Basel III to fraudclosure there are issues that will have to come to ahead at some point in the not so distant future. Specifically, the Financial Times reported that because of the Basel III tier 1 capital requirements the top 35 US banks may be short $100 – $150 billion dollars. This means more capital raises for many of these banks, but don’t worry analysts say this is manageable.

Other parts of the FT’s article states that many of these banks may have to selloff $500B, in total, of assets to avoid the capital raise. The issue is that if all these banks, which the article admittedly says is not equally distributed between the top 35 banks, have to selloff $500B in assets to avoid a capital raise who will buy these assets? If the liability of these assets equals higher capital requirements buyers may be few and far between which means lower prices for the assets being sold or they will have to raise capital. Of note is the shortfall is only because of Basel III and not because of any other issue outstanding.

Remember how so many of these capital requirement issues were supposedly put to rest because of our “stress tests”? Clearly the stress tests, as has been stated time and time again, were worthless. In fact rumors are making their rounds that another round of stress tests are on the way for US banks. What is interesting about this is that the stress tests lack total credibility for 2 reasons. First, look at the EU’s stress tests which passed most banks and look what is happening in Ireland, they were a farce. Second, without good accounting rules, i.e. mark-to-market vs. mark-to-fantasyland, the stress tests are bogus. A loss is a loss and simply pretending it doesn’t exist is the most idiotic thing I have ever heard of and if investors do not do their research it can lead to major losses. In my opinion this is nothing more than state sponsored investor fraud.

What is missing out of all of these bank articles is the whole fraudclosure mess and its impact on the banks. As stated previously there is no remedy for a broken chain of title except to modify the mortgage which starts a new chain of title and eliminates the problem. There are issues with this though. First, doing nothing means that all of those MBS are worthless because there is no cash flow and the creditor cannot collect the collateral, think about that for awhile. Second, if your only option is to modify the mortgage it means that the MBS is worth less than face value. Either way someone somewhere is taking a loss and that means there may be a put back to the originating bank. When the Fed put back bonds to BoA that should concern investors… it’s the Fed telling banks you ripped us off.

If these put backs continue or escalate, which they will because who wants to take a loss on paper that was misrepresented to begin with, that could mean that banks have much larger problems than Basel III capital requirements. If the put back is widely exercised banks will need a lot more money than $100 – $150B. They might need a trillion or more, who really knows anymore? Frankly, Basel III is the last thing anyone should be worried about. People should be worried about what the put back risk is for many of these banks because the put back risk is far greater of an issue than the sub-prime crisis ever was. I believe we will find out if there are indeed “no more bank bailouts” or not. My guess is we will all be shareholders of some big banks in the near future. In the meantime I am waiting for my dividend check from our previously made, wildly profitable, insert sarcasm here, investments into GM, Citi, BoA, Ally…

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QE2: Savior or Suicide

The long awaited decision was announced today by the Fed, $600B in fresh money printing followed by continued reinvestment of proceeds from its first round of easing. This equals about $900B in total QE by our monetary masters. Speculation is rampant in the media about its success or how it will be an epic failure. The funny thing is, no one really knows what will actually happen. Personally, I am still perplexed as to why they are doing it at all, it is stupid.

The Fed is also completely out of ammo which many have stated, myself included, and all they have is the printing press. I want to stress something here and you should pay attention, this whole QE thing is experimental and no country that has ever tried has succeeded. Therefore, I have a predetermined outcome, but at the end of the day you or I have zero idea if it will work. I will lay out a case for its failure based on what I know. I am sure many will disagree and that is fine, but in time one of us will be right.

The economy has a demand problem, not a liquidity problem. Over 2 years ago we had a massive liquidity problem which is why Lehman failed, but now the Fed has dumped trillions into the system along with the federal government. All of that money dumping ended the liquidity crisis and now banks, supposedly, have excess reserves just sitting at the Fed waiting to be loaned out to that sucker who wants to pay 15% interest on money the bank got for free in order to buy that new LED flat screen TV that is just calling his or her name. The problem is the sucker doesn’t want to buy that TV because he doesn’t know if he will have a job next week or is worried about retirement, etc.

We have a demand problem, not a money shortage. I say that with a grain of salt because money velocity is dropping which technically means there are dollar shortages. However, I contend that that dollar shortage is because people are paying off debt to simply saving their money somewhere 9under the mattress??). Regardless of the reason no one wants to buy big ticket items and I do not blame them. After all we got here because of excess debt and no one wants to leverage up to buy senseless items. No amount of QE will change this, sorry, but it won’t. Job security and rising wages will create demand, but that is not happening either. Demand is stuck where it is, weak.

The Fed knows this and they know QE will not change this so why did they do it? I really do not know. Sure, everyone has their own reasons for it, but at the end of the day it is all speculation. I know what they are trying to do, create wage inflation and inflation in general, which they will do eventually, but by their chosen path, QE, they are creating the worst possible outcome, inflation without wage inflation. Stop laughing, it can happen. How you may ask, simple dollar devaluation is inflation, but dollar devaluation does not guarantee wage growth. The only way to get wage growth is through demand with inflation, what the Fed did will not do this. Frankly, everyone should be terrified of Mr. Bernanke and he should be punished for lying to Congress when he said he would not monetize the debt, he is.

I can rattle off all sorts of conspiracy theories as to why the Fed is doing QE, but they are too laughable to mention. I do think one thing makes sense, it is a back door bailout of the banking system, again. There is a little issue I am sure you are familiar with, the foreclosure crisis, and this crisis is a huge, enormous, problem. If you are a bondholder it is one thing to have a borrower default on the debt, the cash flow ends and you get to take the collateral, a home in this case, to recover your capital. However, this whole chain of custody issue, there is no legal remedy for it and all those pundits who claim that this is no big deal are either stupid or scared to admit the truth, means that there is no collateral to collect now. Essentially the borrower can keep the house and screw the lender if the paperwork is messed up, how would you like to own a MBS now? Your bonds are worthless… or are they?

If there was fraud in the loan, as we are now seeing, the bondholder can put back the bond and be repaid their original capital. This is the problem that is starting to rear its ugly head, the put back, and it could be huge. Think about all the paper the banks would have to buy back and now think of all the synthetic derivatives that were written against that bond. What a mess. A big costly web of a mess. I do not know how big the problem can be, but I think part of the QE might help these banks by either allowing the bank to front run the bonds the Fed is buying or by infusing the bank with capital.

It doesn’t matter really, but I think that was one of the reasons for QE2. We have been told for over a year now how great things are now and we are in a recovery so why do QE at all? We have inflation, it is not sky high, but it is there in the PPI and the CPI is still positive. If the CPI were negative I would say we have deflation, but it isn’t and at best we had disinflation which does not justify such a crazy move as monetizing almost a trillion dollars in paper. The Fed sees that no real recovery has happened and maybe that is the reason for the latest round of easing. Regardless, the banks are going to benefit from this, remember the Fed asked them how much they should buy from them.

I stated about a year ago that we can have inflation without wage inflation. We are about to see if that once crazy theory of mine is right. The Fed has now monetized trillion’s in debt and I can say, with history on my side, this has never ended well for any country who has ventured down this path. America is a special place because of our freedoms, but we are not so special that math and history doesn’t pertain to us. All of the people warning about the Fed’s insane moves might be right and the sky very well might be falling. Heck, if things were as great as we have been told over the past few months by the talking heads and our politicians, who no one believes, why are we even having this conversation? Things are not well and I fear we may be in the calm before a very bad storm like we have never seen before.

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Let me be clear, No more bailouts…

The President, Nancy Pelosi, Harry Reid and only God knows how many politicians have all said that the Fin Reg bill ends all taxpayer assisted bailouts for Wall Street. Well, the news lately will put that phrase to the test. To think that all of these foreclosures are not an issue was crazy to begin with, but throw in a little foreclosure fraud and overnight you get a $47B putback from BlackRock and the Fed… go figure.

I believe the putback situation we saw yesterday was merely the beginning and there are many more tens, if not hundreds, of billions of dollars to follow. The banking system cannot handle that type of volume, remember in 2008 it was MBS and derivatives of MBS securities that caused our little problem. There is no easy remedy for this problem, regardless of what JPM or BoA says, since we are talking basic contract law here. Now, Congress did try to sneak through a bill that would have solved the industries problem, H.R. 3808 which would make courts accept all sorts of junk affidavits, but Obama ‘pocket’ vetoed the bill. Do not think that bill went away because it can come back and probably will under a new name, but it will fail in the courts, in my opinion, remember Obama said Congress needed to fix some issues with the bill, a telling statement on his opinion.

Not only does he want Congress to merely make some cosmetic changes to it, but Obama also said that this is just a “minor paperwork snafu.” Oh, how I wish that were true, but it is not a minor snafu. I do not support homeowners who took on irresponsible loans, I have long said they should lose their homes, but I dislike actual fraud even more than irresponsible borrowers. Let’s also not forget that these same lenders often did not verify the borrower’s income either which makes this whole problem a bit ironic as lenders cut corners to give the loan and now they cut corners to foreclose on the collateral. There is a remedy to all of this, as written on Zero Hedge previously, which is a borrower accepts a loan modification which clears the title, guess how successful the HAMP will be now.

If Congress doesn’t create a fix, which they should not, banks will lose foreclosure proceedings to those defendants who decide to fight it. I do not believe anyone really knows how big this problem really is and, frankly, I would not trust anyone who attaches a number to it. After all, these will be the same people who said sub-prime loans were a nonissue a few years ago, the missed that one by a mile, obviously, so they will miss this one as well. Not to mention that this issue will once again be a global issue. Who knows how many of these bonds are sitting on the balance sheet of banks all around the world. Hell, we do not even know what outstanding derivatives are still in play with this paper.

To assume that this will pass with no real material issue to the banks is idiotic. The risk is real and the system is still very, very weak. Perhaps now we know why bank reserves are still so high, did they know this might be an issue? Probably as we know banks do not like to fess up to mistakes until, well, the global financial system is about to implode. The credibility of banks and government has probably never been so low in all of history and that is a problem especially if they need help again. I fully believe another bailout will be needed over this and that means the issues of 2008 will return in 2010 with a vengeance.

Remember, in 2008 it was really the CDO’s and CDS’s on tranches of MBS products that were the problem. We all remember senior and junior tranches that were in the headlines, but back then at least you could get the collateral back to try and sell, albeit at a much lower price. Today if these things are still blowing up and you cannot even get the collateral back that would be a total loss for the investor or bank if it got putback to them. See the problem now? It is just not the banks that have this problem, but the GSE’s as well who may be guaranteeing a lot of this junk now. The GSE’s have $5T in outstanding mortgage guarantees and some say that mortgages as far back as the late 1990’s might not have proper chain of title.

The math is enormous and this should scare people to death. Perhaps it will all go away. Perhaps judges will ignore the 200 year precedents of contract law, they did it with the auto makers, so why not now. However, if this doesn’t go away we are definitely in for a rerun of 2008 again on a much larger scale since even the government is reaching the end of their credit line. Maybe QE2 will buy these securities and that is how the problem will disappear, but if nothing is done the entire mortgage market and perhaps some well known banks are done… again, unless all our politicians lied to us.

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Houston, you aren’t being told about a problem

I admit I have been delinquent on checking out the Euribor rates lately since the Federal Reserve has me scared to death about QE2, more on that later, but I do not think it will be what you believe it will be in November. However, the Euribor went ballistic thanks to the ‘perfectly safe’ Irish banks began to show that the ‘stress test’ were pure bull. How can a bank pass a stress test a couple of months ago and then do insolvent, basically? That doesn’t happen in a normal world and it proves that the ECB totally flubbed the stress test.

The fraud that the stress tests were showing up in the inter banking lending rates which went from benign to cancerous in a heartbeat.  While the Euribor first continued to climb after the stress tests it did level out later in the summer, but now it went vertical and it probably is not looking back. Considering that European banks are still holding only God knows how much US MBS’s, which our current foreclosure fraud situation may render those MBS’s worthless over time, along with how much Greek, Portugal, Italian and Spanish debt and you got serious problems. The media is not going to touch this, but the bank lending markets talks about it only if you look at them.

The 3 month Euribor rate was below .90% until a week ago when it jumped to about 1%, .993% as I write this, which isn’t much until you consider we are in a zero interest rate policy (ZIRP). Actually, we are in a negative interest rate policy right now if you count all the QE going on. When you factor that in it kind of brings to light that something is wrong in Europe, still. US treasuries for 3 months are yielding about .14% so clearly European banks are pricing in a risk premium. The question is, what is the risk premium for? Clearly default is part of it and I think you will see more issues with banks very soon.

It is impossible to have bank holdings that consist of sovereign debt that is in trouble plus MBS holdings and not have any problems. There certainly will be more insolvency issues, but even if a bank is not insolvent their balance sheets will be impaired further. It is a mess and the real problem is that it is just not European banks, but US banks as well. While US banks do not hold a lot of sovereign debt, they do own tons of MBS holdings, unless the Fed buys them from the banks, which foreclosuregate, I hate these names we have now, will make many of these securities worthless or at the very least impair them well below par.

I do not know what is going to happen, but I am convinced that the serious problems that many thought were behind us never really went away. All we ended up having done was the government and the Fed paper over the problems. This went on all over the world with the ECB following suit as well. The Eurubor is telling us something, are many listening? Nope. Stocks are moving higher on some idiotic belief that inflating our way out of this mess will work, it might in nominal terms, but not in real terms. Phony stress tests clearly are not the answer as the fraud gets uncovered when banks that passed suddenly need a bailout. How central banks and governments have any credibility is simply beyond me. When a fraud is uncovered people usually talk about it, but the news on some financial channels is mute on the issue. When lending costs climb rapidly it usually makes news, did you hear about it? Nope. It is all just one big farce out there. I personally believe that the only safe haven seems to be commodities and I believe stocks are not as safe as people believe.

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