International Forecaster Weekly

Expose Transgressions and Set Boundaries on Stimulus Packages

AIG dragged onto the carpet for publishing falsified debt ratings, fines called for when fraud charges should be laid, white collar crime knows no end, books cooked, real estate downside points to deflationary depression, debt continues to grow, borrowing in the debt market again. stimulus packages knowing now boundaries.

Bob Chapman | March 17, 2010

The past week the Connecticut Attorney General Richard Blumenthal sued Moody’s Investors Services and Standard & Poor’s over falsified debt ratings. This suit is the first of its kind against rating agencies under the state’s unfair trade practices law. The AG is seeking penalties and fines that could reach into billions of dollars.

We in this publication have asked for three years why no civil or criminal charges were not brought against these raters, but also against the banks, brokerage firms and the Federal Reserve, which colluded with them in this scam that cost investors worldwide trillions of dollars? These bonds are the collateralized debt obligations, which the Fed purchased from financial institutions over the past year to the tune of $868 billion, which the American taxpayer will have to pay the losses on.

The AG calls this a violation of public trust. We call it criminal activity. We ask why hasn’t any AG in America brought criminal charges against these people? It is common knowledge what transpired. Very simply, MBS and CDO’S were rated AAA when in fact their ratings were considerably lower and have turned out to be junk bonds, which now sell from $0.05 to $0.60 on the dollar. Then there is the matter of what the Fed paid these financial institutions for this toxic waste. Of course, the Fed says it is a state secret and is trying desperately to fend off an audit that would reveal from whom the bonds were purchased from and at what price. Such transparency presently doesn’t exist, because the Fed is itself a criminal enterprise.

It will be interesting to see where this legal action goes. R. Blumenthal may be in way over his head and then perhaps he may just break this episode wide open. It is interesting to note that 60% of these junk bonds were sold to European institutions, yet not one lawsuit has been filed. This leads us to ask why? Has there been collusion between the Fed and other foreign central banks to cover up what transpired? Was the sale of these bonds, which all the buyers had to know were junk if they did their mandatory due diligence, prearranged to relieve Wall Street and banking of this monstrous burden?

We have seen only one media outlet carry this story. Obviously the Connecticut legal action is as usual being blocked out of the news and covered up. The AG called the rating process deceptive and misleading – what an understatement. The AG wants to get the investors money back. We can understand that, but the public should demand criminal charges. This is not a civil matter. A massive crime has been committed and no one seems to care. Why haven’t the banks and brokerage firms been named in the suit, along with the Fed and the SEC? Where were the state regulators while this was going on? Was this some sort of a conspiracy of silence, or are the regulators all simply incompetent?

S&P’s spokesperson says we believe the claim has no legal or factual merit and we intend to vigorously defend ourselves against it. What a slap in the face for investors. Moody’s, S&P and Fitch have already been sued by pension funds for their role, but again why haven’t the other players been sued? The lenders and syndicators of these tranches worked hand in hand with the raters rating these securities. At issue as well is that there was a duel standard for rating government and corporate debt. These raters are accused of giving cities and towns artificially low credit ratings that cost taxpayers millions of dollars in unnecessary insurance and higher interest payments.

White-collar crime in America knows no end. What is extremely disturbing is that litigants always want financial compensation when the charges should be criminal. Our entire financial system is corrupt. There are two sets of rules – one for them and one for us, and it has to stop. If you live in Connecticut ask Mr. Blumenthal why he hasn’t filed criminal charges. Fraud is fraud no matter which way you cut it.

Next on the agenda is further criminal activity. We reported in the last issue that Lehman Bros. used Repo 105 and Repo 108 transactions to remove assets and liabilities from its balance sheet for a short period of time, which enabled them to change their financial condition, which was illegal. This is something Lehman did regularly. Using this method, borrowings could be shielded from scrutiny. This trick lowered their leverage ratios. The players, Richard Fuld, who says he didn’t know what was going on, and Chris O‘Mera, Erin Callan and Ian Lowett, committed fraud. Yet, we see no action by the SEC or the US Attorney’s office. The Federal Reserve Bank of NY and the SEC say they knew nothing of what was going on, but they should have known. In fact, they did know. A number of agencies knew what was going on. In 2008, the SEC and the NY Fed were monitoring the firm and found they failed their tests, but they did nothing to cause a change in the situation. The man that made that decision was Timothy Geithner, then head of the NY Fed and now Treasury Secretary. He was the one who allowed firms to run their own stress tests.

Borrowings were hidden but so were bad or falling assets, such as CDOs. The SEC discovered all this but did nothing about it. Overall the SEC and the Fed of NY knew exactly what was going on and they let no one know what they had found. As you can see the regulators were in bed with Lehman and they continue to have an illegal and unnatural relationship with all large banks and Wall Street firms. It is called too big to fail. This philosophy, which we label criminal fraud, is going on now still at almost all these major firms. As you can see our government and our regulators are owned by Wall Street and banking. Due to this ongoing criminal enterprise we expect more large banks and brokerage firms to go under. They will either be cannibalized by JP Morgan Chase, Goldman Sachs or Citigroup and all the bills will again be paid by the taxpayer, or they will become the problem of the FDIC or the Fed. Either way we get to pay the bills. We have been writing about the criminals at the SEC, CFTC and the FED for years and nothing happens. Maybe in November we can unseat more than 50% of the incumbents, and perhaps have an opportunity to change all this. If we do not change it the public just might take it into the streets.

Cooking the books-Radigan!

January’s delinquent unpaid balance for CMBS rose $4.3 billion to $45.94 billion, up 326% year-on-year, or from $10.94 billion. It is 20 times higher from 3/07 at $2.21 billion. That is up 25 straight months with REOs up 28% month-on-month and 508% year-on-year. As you can see the housing crisis is far from over. This is a sustainable situation as stimulus affects end by the end of April and the Fed pulls back on quantitative easing. We are looking at a 3-year inventory overhang in the face of failing new subprimes at the end of this year, ALT-A, prime and pick & pay option ARMs to fight in the three years ahead. Then if 2013 is the bottom how long do we bump along the bottom, eight years or perhaps 30 years? There is nothing that is sustainable in real estate excepting the downside. This in spite of a trillion dollar infusion by taxpayers. That does not count Fed toxic CDO purchases. This is going to be very negative for the economy. The government’s interference into real estate markets has been and will continue to be a loser. Central planners do not get it. As an example, look at the suppression of the gold price over the past 11 years. Gold went from $250 to $1,200. Government should have let corporations, especially in the financial sector go under and concentrated on creating jobs. The elitists are too dumb to figure that one out. Now everything is worse than it was 2-1/2 years ago and we still have a credit and lending crisis. We would have had a deflationary depression, but we are doomed to have one anyway.

We thought we might have hit bottom a few months ago in Florida, but prices are worse than ever, $250,000 homes selling for $70,000. In California, Nevada and Arizona the same is about to happen in spite of the better part of the real estate season before us. You can imagine what will happen when the stock market heads down again.

Debt continues to grow exponentially, especially sovereign debt. As long as this continues the end of the debt cycle grows closer. Raising money for debt gets more and more difficult as debt grows larger. Then comes bankruptcy or in today’s case, perhaps 19 bankruptcies. Debt today is far beyond that of 1930 and growing.

In spite of innovations such as securitization and quantitative easing, and major increases in money and credit, their velocity is easing as the credit crisis continues. These instruments of mass destruction were in part created and encouraged by the Fed to keep America out of depression and as a result Wall Street and banking’s greed took over. You know the result of that. As we pointed out earlier on a giant fraud that was committed by securitizers and raters. During the period from 2001 to 2007, banks took this massive supply of money and credit and lent it, but not at 8 to 10 to one, but at 30 to 70 to one. They still are leveraged at an average of 40 to one, which is suicidal and they know it.

The Fed on the other hand encouraged this. Today instead of expanding lending banks are contracting lending some 15 to 20 percent. Major corporations have more money than they have ever had before. They are in great shape and can borrow all they want. That was accomplished by working employees harder than ever as borne out by productivity gains of some 6 percent, enforced part-time employment, which has given us a 33.1-hour workweek and unemployment of 22-1/8%. That is U6 with the birth/death ratio extracted. The corporations may be in good shape, but the American worker has been so screwed into the ground, that millions may be on unemployment indefinitely, as fiscal debt heads for the moon as sovereign default looms in the wings.

As many as 7 million Americans could easily lose their homes this year and that should continue to lower consumption, which is now about 69-1/2% of GDP, down from 72%. Unemployment is worsening not improving. A little more than 30% of capacity utilization is idle up from 66%. Fifteen percent of existing homes have no one living in them and that figure could almost double this year. Twenty-five million people are unemployed or under-employed.

If money and credit falls, the Fed removes stimulus, the banks continue to refuse to lend to individuals and small and medium sized businesses, if fiscal stimulus stops (and it will run out in April), if taxes or interest rates increased the bottom would fall out of the economy. The fiscal budget deficit could be $1.8 trillion this year and next year looks just as bad. This is not a happy story and we believe things are going to get much worse.

David Rosenberg says retail sales fell 1.6% m-o-m in February.

The March NAHB housing market index fell from 17 in February to 15 in March as homebuilder sentiment fell. There is little credit available for new projects.

The FDIC Friday Night Follies of bank failures add three more.

AIG has transferred $46 million from the taxpayers to derivatives traders. These are the same traders that have already cost taxpayers $100’s of billions of dollar. AIG is still losing billions of dollars every quarter - bonuses for losers. Makes you fell just great doesn’t it? Last week the Dow added 0.6%; S&P 15; the Russell 2000 1.6% and the NASDAQ 100.1%. Banks rose 3.8%; broker/dealers 1.1%; regional banks 5.5%; cyclicals 1.3%; transports rose 3.1%; retail rose 2.3%; restaurants rose 4%; high tech rose 2.2%; semis 1.1; Internets 2.8% and biotechs 4.7%. Gold bullion fell $32.00, as the HUI fell 2.9%. The USDX, the dollar index, fell 0.8% to 79.80. The big winners were the Swiss franc, up 1.5%; the Norwegian krone 1.1%; the Korean won 1.1%; the Canadian Dollar, up 1.1%; the Danish krone up 1.05; the euro up 1.05; the Swedish krone 0.9%; the Brazilian real 0.9%; the Aussie dollar 0.8% and the Mexican peso 0.7%.

In gauging the economic recovery's trajectory, you shouldn't forget that this is not a normal tax season.

People who don't pay income tax are getting an extra $30 billion in refundable tax credits thanks to the Recovery Act, the Joint Committee on Taxation has estimated. Based on the timing of tax refunds in past years, well over half of that has likely been paid out already.

Mark Zandi, chief economist at Moody's, said the extra serving of tax-season cash to modest-income families "helps explain the somewhat surprising strength in retail" in February.

But this tax-season windfall is more than just another gush of short-lived economic fuel. It also signals that government stimulus is peaking, meaning it won't raise GDP levels any further .

Most discussions of the timing of stimulus cite Congressional Budget Office projections that the Recovery Act will have its maximum impact on GDP in Q2. But that includes an estimated $82 billion in relief from the alternative minimum tax, which is really just an extension of current policy.

Excluding AMT relief, Zandi figures peak stimulus hits this month or next.

Just how big of a boost will this extra cash provide? If the economic impact came in a single quarter, CBO's analysis implies that it would hike GDP by 0.6-1.5 percentage points. In all likelihood, the effects will be over a longer period.

The IRS will issue its first tax season update in the coming week, which may provide a clue about how much of this income has already flowed into the economy.

In the 2008 filing season, 52%, or $137 billion, of all refunds had been issued by the first week in March.

Robertson Williams, senior fellow at the Tax Policy Center, said that those without tax liability are likely to be among the first filers.

Two factors might diminish the punch from larger checks from the IRS this year, he said. People may have anticipated the refund and spent it already, or these modest-income households might also have outstanding debts to pay down.

"I think we are seeing the effects (of Recovery Act tax refunds) on retail sales and spending," said Allen Sinai, president of Decision Economics.

Same-store sales at major retailers rose 4.1% in February, the best year-over-year gain in over two years, Retail Metrics said March 4.

The Commerce Department will release its broader retail sales report on Friday.

Sinai expects the bulk of retail impact to come in March and April.

"There are a number of temporary boosts that are going to fade," said Zandi.

Not long after the impact of stimulus flattens out, so too may the boost from faster production to raise depleted inventories. Census hiring of 1 million workers will begin to reverse over the summer as those temp jobs come to an end.

Along with a potential foreclosure wave as modifications fail, Zandi sees "a significant stress point" in late summer or early fall. But he expects the economy to overcome it.

He's encouraged that Congress is moving to extend expiring stimulus aid. That means fiscal policy, while no longer propelling growth, won't act as a drag in the second half of 2010.

The biggest portion of the tax-season windfall — $18 billion — is tied to President Obama's Making Work Pay tax cut of $400 per person. Ironically, the tax cut was designed so it took roughly a year to get to the neediest families. By contrast, middle-class workers saw an almost immediate cut in taxes withheld from their paychecks.

Nearly $10 billion is tied to expansions of the Earned Income Tax Credit and child tax credit. Almost $2 billion is tied to the American Opportunity Credit, which offers up to $1,000 per college student in families with no tax liability.

All these provisions will offer another lift in the 2011-filing season.

Companies are aggressively borrowing in the debt markets once again. In the U.S., bond sales by companies such as Bank of America Corp. and GMAC Financial Services are on pace to conclude their busiest week since the beginning of the year. In Europe, borrowing by companies so far in March is already more than 60% of February’s totals. So far in 2010, U.S. corporations have issued $195.2 billion of debt, excluding government-guaranteed bonds, according to Dealogic, up from $166.8 billion during the same period in 2009. Some $375.4 billion flowed into bond mutual funds last year, compared with an $8.7 billion outflow from equity funds, according to data compiled by the Investment Company Institute.

U.S. regulators are encouraging public pension funds that control more than $2 trillion to inject capital directly into the banking system by buying failed lenders.  The Federal Deposit Insurance Corp. is trying to attract pension funds that want to buy stakes or assets of distressed bank-holding companies, according to two of the people.

In California’s Napa Valley, producer of the most expensive U.S. wines, 2010 may be a vintage year for foreclosures. As many as 10 wineries and vineyards in Napa will change hands in distressed sales or foreclosures this year and next, up from none in 2008. We have 250 vintner clients saying this downturn is the worst in 20 years, Bill Stevens, manager of [Silicon Valley Bank’s] wine division in St. Helena, California, said. Anybody who was late to the party won’t have staying power.

The U.S. budget deficit widened to a record in February. The excess of spending over revenue increased to $221 billion last month, compared with a shortfall of $194 billion in February 2009. The figures show the deficit this year will likely surpass the record $1.4 trillion in the fiscal year that ended in September.  Spending for February increased 17% from the same month a year ago, to $328.4 billion. Revenue and other income rose 23% to $107.5 billion, marking the first increase in receipts since April 2008.

As the Federal Reserve wraps up its $1.25 trillion mortgage-purchase program, risk premiums on mortgage-backed securities backed by Fannie Mae and Freddie Mac have improved unexpectedly. In the past week, the market prices of these securities, also called pass-throughs, have improved so much that risk premiums, or differences in spreads over comparable Treasury yields, are at the narrowest level of the year and pretty close to the firmest level last year.

For all of 2009, U.S. Non-Financial Debt (NFD) expanded 3.3%, down from 2008’s 5.9%.  In nominal dollars, NFD expanded $1.116 TN, the smallest expansion since year 2000 ($865bn).  There has been much discussion about the ongoing Credit contraction.  For the year, Household Home Mortgage debt contracted $165bn, Consumer Credit contracted $113bn, and total Business borrowings contracted $200bn.  I have tried to highlight the massive counterbalancing inflation of “federal” Credit.  Federal Government (Treasury) Credit expanded a record $1.444 TN last year (2-yr gain of $2.683 TN) and GSE-Mortgage-Backed Securities grew $422bn (2-yr $920bn).
In the Domestic Financial Sector, borrowings fell an unprecedented $1.753 TN for the year.  Bank Credit declined $467bn, GSE Assets dropped $371bn, and the Asset-Backed Securities (ABS) market shrank $675bn.  At the same time, the Fed’s holdings of Agency and GSE-Backed Securities ballooned $979bn.

The market today perceives that essentially no amount of stimulus or monetization is out of bounds.  The Fed is there as a backstop bid for debt securities, while the Treasury and Federal Reserve have teamed to establish a floor under GDP/national income.  Market malformations now lie at the heart of the unfolding Bubble and go a long way toward explaining the market’s complacency when it comes to the simultaneous contraction in private-sector Credit and the explosion of federal debt and obligations.