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Posts Tagged ‘debt crisis’

I could write volumes on what happened last week.  I am just going to stick to the most recent news which is the almost 1 trillion dollar bail-out of Greece and everything that ails Europe.  No worries – After last week’s market decline, we wake up to find that the Europe Central Bank is delivering an almost 1 trillion dollar bail-out to solve the problem.  In other words, they are going to fix the debt crisis by issuing more debt.  It gets even better.  The Federal Reserve is also assisting in that bail-out package. 

Taking these enormous steps to save the system just goes to show how close to the brink the euro might have been last week.  Does it solve the problem?  Does the market just go up from here?  

There are several points to consider.

The Europe Central Bank is not the Federal Reserve – The United States can pull something like this off.  It is very suspect that the ECB has the ability to pull the same “solution” or push the problem off into the future without a hitch.  Just like the US, they have no room for mistake and the EU is in an environment where mistakes can easily happen.

The US Government made their big bailout attempts in 2008 first on September 19th and then the TARP on October 3rd.  Following those heroic methods to save the system, over the next 6 months the stock market dropped -40%.  Initially after the bailouts started, we saw the same type of positive stock market action as we are seeing on Monday.  However, it gave way to further large declines.

There are still a lot of European politics to get around.  Politics, the euro, and cultures are vastly different than here in the US.  This solution is not a done deal.  In addition, Greece and some other parts of Europe will still have to deal with the social and civic unrest and backlash. 

If this gets pulled off, we are maxed out as a world economy when it comes to creating more debt to handle current debt problems and pushing current crisis out into the future.  Thus there is no room for any other problems while walking this financial tightrope.  Utilizing the vast majority of the IMF (international monetary fund) to bail-out Europe (of which the US funds 18%) is the last resort.  There are many more countries that could potentially need help.  Further, if this thing doesn’t work (and I believe the odds are that it will not work) look out below.  Debt might end up being Europe’s kryptonite and Superman might not save the day.

Don’t be fooled into believing that the problem in Europe is fixed.  This is an area on the globe that is walking a tightrope.   This is a much bigger problem with many moving parts that connects all of us.

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Please excuse any typos.  My assistant is out today and she normally proofreads my writing. 

There are so many facets of a debt crisis.  Unfortunately, there are many categories of debt that make up a debt crisis.  We have looked at the potential debt crisis in foreign debt.  Next week I am going to write an update on what is happening with mortgage debt.  This week I want to talk about municipalities.  Cities and states appear to be in trouble when it comes to debt. 

Last week, Jamie Dimon of JP Morgan made the statement that California was a worse problem than the country of Greece and is closer to being on the brink.  Of course, the big difference between a debt problem with Greece and a debt problem with California is that we can print money and save California (as if that is a good long-term solution).

Cities and states are feeling the financial squeeze.  The Rockefeller Institute of Government recently confirmed that state revenues fell through the first 3 quarters of 2009, the largest drop in 46 years.  The fourth quarter report showed even deeper declines in tax revenue, extending the decline to 5 straight quarters. 

California faces an estimated 20 billion dollar plus budget deficit.  California represents the 8th largest economy in the world.  By the way, Greece only represents the 34th largest economy in the world.

It is estimated that 43 of the 50 states are in financial trouble right now.  Twenty-one states have already put a number on their 2010 budget shortfall which totals over 60 billion dollars thus far. 

Some of the more noted states that are in trouble:

Budget Shortfalls

New York        $5.5 billion

Florida             $5.1 billion

New Jersey      $2.5 billion

Arizona            $2 billion

Nevada            $1.2 billion

The money has to come from somewhere.  States cannot claim bankruptcy.   As with any type of debt scenario, if the money cannot be paid back, a loss must be created.   Who is going to take that loss?  This is where it might become tricky for municipal bonds.  Bondholders could be at risk.  Through a municipal bond, an investor has essentially become a creditor by lending the city or state money and in return receiving a bond for it.

Would you feel comfortable lending money to a municipality?  By investing in a municipal bond, you are lending money.  With the problems that we are seeing, I don’t know that municipal bonds are such a great bet.

Incidentally, what we are seeing with states and cities is classic deflation.  These budget deficits and debt potentially create enormous losses due to the destruction of debt.  Once again, it is tough to see where inflation is going to come from with all of these debts waiting in the wings.

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If I were a banker, I would dread Friday’s.  It is the day of the week that the federal regulators walk in and shut banks down.  This past Friday there were 4 more banks in Texas, California, Illinois, and Florida bringing the total bank closures for 2010 up to 20.  This is on the heals of 140 being closed in 2009, 25 in 2008, and 3 in 2007.

The troubling part of this whole process is that last year banks were able to push the problems aside as the Government allowed them in short to hide these bad loans on their books through an accounting adjustment.  In other words, all of those toxic bank killing loans are on the books and have not been dealt with. 

It gets better.  The FDIC gets to pick up the tab each week through the FDIC insurance fund.  Currently, the fund has $21 billion left.  They estimate $100 billion of losses will have to be covered over the next 3 years.  Oh, don’t worry – they have a credit line that can be tapped up to $500 billion dollars through the Treasury. 

Don’t forget, a massive foreclosure problem still lingers as we start a huge wave of adjustable rate mortgages re-setting over the next 3 years.  In 2009, we were in the calm of the storm as the first wave of adjustable rate mortgages which were sub-prime based were finishing up with their adjustments.  This next wave which represents Alt-A and Prime mortgages is much bigger.  In addition, the fun is just getting started in the commercial space where corporations are having to refinance debt on commercial properties and are having no luck because no one is lending money. 

John Mauldin writes this week in his www.frontlinethoughts.com newsletter “Bank loans are being written off at staggering rates. Over 700 banks (I think that is the figure I saw) are officially on watch by the FDIC, with more banks being closed each week.  There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off.”

He goes on to write that in January, “Foreclosures rang up at 4300 and Notice-of-Defaults at 5100 per day nationally.”

Think through with me what this could look like.  This last Friday’s 4 bank closures cost the FDIC approximately $1 billion.  That’s an average of $250 million per bank.  If we continue at this pace, we could be looking at 100 more bank closures this year.  That could be as much as $25 billion.  That would deplete all of the FDIC money and force the FDIC to borrow from the Treasury before year end. 

This can’t have a happy ending. 

This week the Sovereign Debt Problem will be front and center as Greece attempts to borrow money through a bond offering.  As I wrote last week, this could be a real problem in the event that Greece defaults.  Also this week we have the unemployment numbers that will be released.  It is a critical number each month.  Watch the risk!

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There is an intense debate on Wall Street about whether or not we are heading towards a massive inflationary problem or if we are stuck in a deflationary problem.  Inflation is when prices go up and deflation is when prices go down.

If you are investing money, it is going to be important to get this one right.  So many of the talking heads on CNBC are declaring that we are heading towards extreme inflation.  They cite that the printing of money by the government is causing it.   They also point to this “incredible” rebound we are seeing in the economy.

If you will bear with me, I need to put the KOOL-AID down so that I am not tempted to drink it.  On the surface, it is inflationary when the Government prints enormous amounts of money.  However, the story goes well beyond the printing of money.  I regard these financial hosts as pretty smart people.  I often wonder if these hosts are all told to always be positive no matter what?  After all, they do work for CNBC, which is owned by GE, a publically traded company. 

Here is the evidence of deflation:

The velocity of money – Dig out your economics book. The velocity of money measures the circulation of money throughout the economy.  The velocity of money would need to be running pretty high to potentially create inflation.  Currently it is very low primarily because banks aren’t lending money and consumers aren’t spending money.

A world overloaded with debt – Debt in itself is deflationary.  Deflation is brought on by a debt crisis. 

The money supply – The money supply has been decreasing and not increasing. You would need to see the money supply expanding at a great pace to see inflation.  

The CPI and the PPI – The PPI or Producers Price Index shows whether or not the prices or increasing or decreasing at the producers level.  In other words, are the widgets getting more or less expensive to make?  The CPI or consumer price index shows what is happening to consumer prices. Are they going up (inflationary) or down (deflationary)? 

The latest PPI numbers showed an increase in prices at the consumer level.  When that happens, typically those higher costs get passed onto the consumer and are reflected in the CPI number.  However, the CPI numbers released on Friday showed the first drop in 27 years.  That tells me that companies are getting hit with higher costs but are not able to pass them on because the consumer is so strapped.  That keeps a lid on prices.  In fact, companies are dropping prices to get consumers to buy items.  That in itself is deflationary.

To be fair, the CPI minus energy and food costs decreased.  Yes we depend on energy and food which have been going up.  I think that net effect is clearly deflationary.     

In short, the reason that the printing of money is not causing inflation is simply because the printed money is not circulating.  It is absorbing losses of all kinds due to the effects of the debt crisis.  Until you get massive circulation which would show up in the above indicators, I think that we are stuck with deflation.  Plus you better hope that it doesn’t turn into inflation.  That would force the Federal Reserve Board to start aggressively raising rates which would easily throw us into a double dip recession if we aren’t already heading that way.

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The problems overseas aren’t settling with the markets very well and for good reason.  You have the developing problem in Europe with the first of many debt plagued countries on the brink of defaulting on their debt.  Greece is begging for a bail-out.  The EU tells Greece not so fast.  If you want help with your debt in the form of a guarantee by the EU, then some tough choices are going to need to be made.  Greece will actually be forced to cut spending and oh no…make wise financial decisions.  Oh the horror…

The day of the US style easy money bail-outs are over.  Now, bail-outs come with tough terms and conditions.  Shouldn’t it be that way?  Would the US be in a much better place if our creditors would have told us that the US can borrow money as long as changes were made?  The problem is that we are borrowing the majority of our money from ourselves.  So, that would mean we would be forced to actually be wise and make prudent fiscally responsible decisions on our own.  As long as there are politicians in Washington, that will not happen.

John Mauldin points out that there is no good solution for Greece.  The terms and conditions of a bail-out are going to be as tough as the cons of defaulting on debt.  The following is from his latest frontlinethoughts newsletter. This is one of the most excellent resources for investors and is free.  Everyone should be signed up for this newsletter. 

While German Chancellor Merkel has indicated a willingness to help, the German finance minister and other politicians are suggesting German cooperation will either not be forthcoming or only be there at a very high price; and the price is a severe round of “austerity measures,” otherwise known as budget cuts. Greece is being told that it must cut its budget to an 8.7% deficit this year and down to 3% within three years.

Now, here is where it actually gets worse. If Greece bites the bullet and makes the budget cuts, that means that nominal GDP will decline by (at least) 4-5% over the next 3 years. And tax revenues will also decline, even with tax increases, meaning that it will take even further cuts, over and above the ones contemplated to get to that magic 3% fiscal deficit to GDP that is required by the Maastricht Treaty. Anyone care to vote for depression?

And add into the equation that borrowing another E100 billion (at a minimum) over the next few years, while in the midst of that recession, will only add to the already huge debt and interest costs. It all amounts to what my friend Marshall Auerback calls a “national suicide pact.”

The problem is that this is just the problem with Greece.  There are many other countries that are going down the same path.  It is much like the domino problem that we had with the banks and financial institutions in 2008. 

Then there is Dubai.  Dubai created a shock across the markets when it was disclosed in December that they were on the verge of default on their debt.   Well, apparently Dubai has not done anything to solve this problem.  CNBC reported today that “Dubai World will offer creditors either 60 percent repayment over seven years and a government guarantee, or full repayment with a debt for equity swap for property assets of Nakheel and no guarantee.”

Those aren’t good solutions.  The issues that we still deal with in an ongoing financial problem in our own country are seemingly contained in the fact that everyone is getting use to the new normal.  However, the sovereign debt (debt from other countries) crisis is a whole other deal and new dynamic for the markets.  We could be seeing the start of financial crisis round 2.

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With a new year the predictions are everywhere.  Will the economy continue to stabilize? Will the stock market continue to go up? What are the pros saying? It is what they are saying as a majority that has me the most concerned. This is the time of the year where everyone is predicting how the new year will turn out. Personally, I am a recovering prognosticator and refuse to predict anymore after the bad predictions from last year. Granted, I was right about the first quarter and the continuation of the bear market. However, I couldn’t have been more wrong about what happened at the lowest point in March. So, let’s take a look at the prediction business and have some fun.

First, this is what concerns me. There is an old saying that goes like this – “When everyone thinks the same way, usually everyone is wrong.” Today everyone thinks there is no risk in the market. Everyone is bullish. In fact, today the level of optimism is higher than in October 2007 (top of the bull market), than in January 2000 (top of a bull market), and in August 1987 (two months before the second largest stock market crash on record.) When everyone is optimistic or pessimistic, things usually change. Danger – everyone is packed into a crowded party. What are you going to do when someone yells FIRE!?

Unusually High Levels of Optimism

I heard one analyst this morning who was just gushing with optimism about how high the stock market is going to go.  Then in the same breath he said: If we continue to see the same type of economic numbers going forward, I am very positive about the stock market.

Let me state the same thing in football terms. If the Dallas Cowboys continue to play the way they are playing now, I am very optimistic that they are going to the Super Bowl. What are the probabilities that the Cowboys are going to continue to play the same way? Minus the fact that Wade Phillips is unproven as a head coach that can take a team to the championship, I think that they are good. Things are clicking for the Cowboys. What are the chances that the economy is going to continue to improve? The economy is improving on the heels of a big shot of Government intervention that has created this false level of growth in the economy. I will not bore you with the long list of risks to investments today.

I will just ask one question. What are the chances that we just cruise on through without any ill effect of the debt crisis and continuing irresponsibility of the Government bail-out and cover up programs? Well, only time will tell. The quality of a prediction always comes down to the assumptions that are being made. I think that it is extremely risky to assume and base the fate of your investments on the probabilities that things are just going to run along smoothly in this economy when we face an unprecedented amount of challenges.

Next week – As I wrote earlier, I am out of the prediction business. However, I will present you next week with what I think are the probabilities for 2010 and what you need to put on your radar. Incidentally, tomorrow on the Prudent Money blog I will follow up with the counter argument to the point I am making today. Make sure and catch it.

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Cracks in the foundation are starting to rear their ugly heads and investors need to wake up smell the risk.  In my latest client newsletter, I wrote about the great disconnect that exists between Wall Street and Main Street.  On the one hand, you have Wall Street who just assumes that this is a normal cycle and the worst is behind us.  Then you have Main Street that is really suffering.  We all know several people who are facing tough financial times or at least have heard the stories. 

The Wall Street Journal reported last week that 1 out of 4 homes are underwater.  That means these homeowners owe more than the worth of the home.  If you look into the stats even more closely, you get a real disturbing picture.  The numbers show that 65% of the homes in Nevada, 48% of the homes in Arizona, and 45% of the homes in Florida all have values of the home less than what is owed on the home. 

This translates into a large number of potential foreclosures.  The real estate markets cannot even get close to starting the recovery process until the foreclosure crisis starts a recovery.  I think that we are a long way away from that starting.  Overall, I don’t think that we can get a healthy recovery until you fix the real estate and foreclosure problem.  All of these problems tie together spelling risk for the economy and risk for the markets. 

There is no question that these risks are known by the market.  However, the market expects that this recovery will take place much sooner.  Therein lies the problem.  I don’t think that Wall Street’s time table is even close to reality. 

Wall Street also thinks that most of the debt crisis is behind us…well maybe until last week when Dubai revealed they are going to stop making the interest payments on 60 billion dollars worth of debt.  Dubai is on the verge of defaulting on 60 billion dollars worth of debt.  That would have some serious implications for a global economy that is already walking a tightrope. 

Todd Harrison, president of Minyanville.com, described how the crisis would unfold. 

  • Dubai defaults.
    European banks (such as HSBC (HBC) and Royal Bank of Scotland Group (RBS)) are counter-party on much of that risk.
  • The virus spreads through the fragile region (debt insurance has now spiked in Bahrain, Qatar, Turkey, Russian, Ireland and in particular, Greece).
  • The strain migrates to stateside financial institutions, as you would expect with $500 trillion in derivatives tying the world together.  We see a “flight to quality” with a sustained rally in the US dollar.
  • Santa has a grumpy Christmas
  • It was announced on Sunday that their central bank would bail them out.  Oh good, another bail-out.  It might be a little early to see how this plays out. 

    How many more Dubai’s are out there that the market doesn’t know about?  We are talking a debt crisis of epic proportion.  I still don’t think that we have seen the end of the debt crisis. 

    We are also seeing the reality of the condition of the consumer.  Consumer sales were not that great this Black Friday  and don’t look to translate into a strong Christmas buying season.  Be careful if you are drinking the kool-aid.  These markets can go down as fast as they went up.

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