Rolfe Winkler

Bank regulators issue interest rate advisory (FFIEC) This may sound boring, but it’s rather important. The FFIEC — a collection of bank regulators including FDIC, OCC, the Fed, OTS and NCUA — hasn’t issued such a warning since 1996. It wants banks to make sure they can handle rising interest rates….which seems to me a HUGE disincentive to lend. 5% mortgages originated today will lose mucho value as rates go back up. This is a huge reason banks “aren’t lending,” because up is the only direction for rates to go!

Employers unexpectedly cut jobs in December (Mutikani, Reuters) The jobs report is an important catalyst for the dollar and gold. If the employment situation improves, it will be easier for the Fed to tighten (good for dollar, bad for gold). If unemployment stays high, the Fed will keep rates low indefinitely and likely keep printing money to buy assets (bad for dollar, good for gold).

U.S. now renter’s market (Timiraos, WSJ) Hooray for deflation! As I’m fond of reminding folks, rents midtown west neighborhood of Manhattan crashed over 20% last year. That’s oodles of spending power freed up to pay for other things. Yes, it’s probablematic for landlords and the banks to which they owe money. But it’s good for the economy overall. Letting house prices fall will have a similar stimulative impact.

Why does it feel worse than reported? (EconomPic Data) Comparing Gross Domestic Product with Gross Domestic Purchases demonstrates how we lived beyond our means for so long and why getting back to equilibrium feels so painful.

Bubble warning (Economist) Not a new thought (argued it myself in sep ’08), but Economist is great at summarizing issues.

Swiss speeding motorist fined $290,000 (Rhodes, Reuters) Finland also does a means test for speeding tickets. This makes so much sense. Can a millionaire with dangerous driving habits be reformed if he’s only looking at a fine of a couple hundred bucks?

The Messiah complex (Brooks, NYT) Brilliant comment on the plot of Avatar. Brooks’ last two paragraphs are particularly good.

R.I.P., WTO (Blustein, Foreign Policy) Will the WTO die in 2010? I have to admit, I’m questioning my own belief in free trade. My default position is to favor it at every turn due to the wealth effects of comparative advantage. That said, I wonder if cross-border trade is growing faster than our ability to manage it…

Great find on Antiques Road Show (PBS)

Happy birtday Stephen Hawking (Wired)

by Warren Mosler

1.  A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%).  This will restore ‘spending power’ and, by allowing households to make their mortgage payments, will fix banks from the bottom up.  It may also keep prices down as competitive pressures may lead businesses to cut prices, passing on their tax savings to consumers even as sales increase.

2.  A $500 per capita federal distribution to all the states to sustain employment in essential services, service debt, and reduce the need for state tax hikes.  This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP would be restored.

3.  A federally-funded $8/hr job and healthcare benefits for anyone willing and able to work. The economy will improve rapidly with my first two proposals and the private sector far more readily hires folks that are already employed. In 2001 Argentina implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years, 750,000 of those 2 million were employed by the private sector.

4.  Making banks utilities. The following are disruptive, serve no public purpose and should be done away with:

–Secondary market transactions
–Proprietary trading
–Lending against financial assets
–Business activities beyond approved lending and bank account services.
–Contracting in LIBOR. Fed funds should be used.
–Subsidiaries of any kind.
–Offshore lending.
–Contracting in credit default insurance.

5.  Federal Reserve — The liability side of banking is the wrong place to impose market discipline.

The Fed should lend in the fed funds market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as the FDIC already regulates and supervises all bank assets.

6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than otherwise.

7.  FDIC

–Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
–Don’t tax good banks for losses by bad banks. This serves only to raise interest rates.

8.  The Treasury should directly fund the housing agencies to eliminate hedging needs while directly targeting mortgage rates at desired levels.

9.  Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the government at the lower of the mortgage balance or fair market value of the home.

10.  Remove ‘self imposed constraints’ that are disruptive to operations and serve no public purpose.

–Dump the debt ceiling – Congress already votes on spending and taxes.
–Allow Treasury ‘overdrafts’ at the Fed rather than forcing it to sell notes and bonds. This is left over from the gold standard days and is currently inapplicable.

11.  Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only to cool down an overheating economy, and not to ‘pay for’ anything.

Sheila Bair looks to be leading the regulatory race to the top. The agency she oversees, the Federal Deposit Insurance Corporation, has recently unveiled a handful of clever ideas to contain risky bank behavior and protect the nation’s deposit insurance fund. Rival watchdogs fighting for turf will find it difficult to ignore FDIC’s latest tactics.

Generating the most buzz is a sensible plan to tie the amount that banks pay for deposit insurance to the riskiness of their compensation plans. Banks with schemes that favor short-term gains would pay more than those that, for example, include multi-year claw-backs on bonuses. The agency will vote on the plan next week.

Of course, this comes as the Fed is also implementing its own proposal to include executive pay in its overall assessment of bank stability. It’s not clear which agency will be more stringent. But a little competition among the two wouldn’t be the worst outcome after years in which banking regulators rivaled each other in their laxity.

Linking pay to insurance premiums follows a handful of other changes FDIC is making. It recently revised the formula it uses to assess how much interest undercapitalized banks can pay to attract deposits. The net effect of the changes will be to reduce the rates banks can pay by an average of 12 basis points, analytics firm Market Rates Insight estimates.

This is a clever way to limit moral hazard. Failing banks, more concerned with survival than profitability, often make last-ditch attempts to attract new deposits by offering ultra-high rates on savings products wrapped by FDIC insurance.

Similarly, FDIC is pushing for a form of schmuck insurance from the buyers of failed bank assets. To mitigate some losses the fund incurs on assets in receivership, FDIC  is pushing for the buyers of the assets to make payments linked to the increase in their share prices following the announcement of a deal.

In isolation, these may look like incremental, if sensible, changes to the way FDIC does business. But in the context of a regulatory turf battle over power and resources in Washington, it’s an encouraging sign indeed.

by James G. Rickards

The debate between Keynesianism and Monetarism is over; they both won. Obama’s approach to the crisis is breathtakingly simple – print money and spend it fast. For Keynesians, stimulus substitutes for private demand until the latter is jump started and stimulus can be reversed.  For Monetarists, the logic is equally simple – increase the monetary base to expand GDP.  Don’t worry about inflation until you see the whites of its eyes. Then withdraw the money after the job is done.  Easy.

But what if Keynesianism and Monetarism are both fatally flawed? The evidence for a Keynesian multiplier is that there isn’t one.  At best it’s fractional, maybe 60 cents for each dollar spent.  Intuitively its hard to see how taking a dollar from the private sector and washing it through government creates any growth at all; experience says that part of the dollar is wasted; evidence bears that out.  For Monetarists, the relationships among money, prices and GDP break down once velocity is considered.  Targeting money against potential 3% real GDP growth is child’s play if velocity is constant.  When velocity drops in hard to measure ways, central banks are driving blind.

Apart from these flaws, Keynesians and Monetarists are wedded to the linearity of stocks and flows.  The idea is that some stock, such as money or deficit spending, can be dialed-up to create some flow, such as GDP growth in predictable ways.  But markets are complex nonlinear systems; inputs and outputs bear no predictable relationship except in sub-critical states.  The key question for policy is whether the financial system is in the critical state, i.e. dynamically unstable.  This is impossible to answer because the computational complexity defies analysis.  But it is possible to say with certainty that we are closer to the critical state than ever because of globalization, derivatives and leverage.  As scale increases parametrically, complexity and risk increase exponentially.  Critical thresholds at which diverse actors reject dollars in a cascading collapse are too near for comfort.  Pushing the system by money printing and deficit spending are not reversible probes but lethal catalysts which may ruin the U.S. dollar and federal finance.

What is needed is what has always worked: sound money, low taxes and light regulation.  This means raising interest rates and all that implies for valuations and bank collapses.  Lower taxes means higher deficits but there is a world of difference between deficits caused by spending and those caused by lower taxes; the former crushes creativity while the latter frees animal spirits.  Light regulation does not mean no regulation.  Reinstating Glass-Steagall and separating deposit taking from gambling would be a good start.  If this medicine causes hardship, use spending to mitigate that with unemployment benefits, food stamps, rental assistance and education, rather than profligate spending on inefficient technology and state jobs.

Keynesian and Monetarist approaches are not merely based on flawed assumptions about multipliers and velocity.  They are dangerous in a complex nonlinear world.  Classic sound policy and a dose of humility are needed now.

James G. Rickards is a writer, lawyer and economist.  Twitter.com/JamesGRickards.

Tim Geithner covered up AIG’s payments to counterparties (DealBook) Timmy G. knew it looked bad for AIG to pay out 100¢ on the dollar to counterparties like Goldman. So he told AIG to shut up.

Obama buget will raise “carried interest” tax (Comstock, Business Insider) Awesome proposal from the Prez. Recall that hedge-funders and PE guys can treat their partnership income as capital gains. As a result they’re only taxed at 15% instead of normal income tax rates of 35%. Last time this came up, Chuck Schumer killed it. This time it’s likely to happen.

Obama OKs taxing high-end health plans (Werner, AP) Another good move. It’s Republicans who’ve argued that such health plans should be taxed so this will get bipartisan support if Dems get on board. Unions oppose it so this demonstrates some backbone from Obama.

New Japanese finance minister calls for more stimulus, weaker yen (Kajomoto/White, Reuters) Debt surpassing 200% of GDP doesn’t faze the new guy…

Redrado fight roils Argentina’s markets (Cowley, WSJ) Argentina’s president wants to fire the central bank chief for refusing to release reserves to pay down debt. He says he won’t go. He has the backing of Congress too. RBS says it’s an opportunity to buy Argie debt.

Banks favorite Dem set to replace Dodd (Grim, HuffPo) Tim Johnson is from SD, the home of credit card processors. He’s the only Dem who voted against credit card reform. He also opposes cramdowns and is a supporter of pay-day lenders…

Fed conflicted on MBS purchase program (Aversa, AP) The Fed has promised to stop printing money to buy mortgage-backed securities this March, after buying $1.25 trillion total. There are many who think the Fed is trapped and can’t step away. Not only will they never sell what they bought (effectively monetizing mortgage debt) but they’ll continue buying to support the housing market. Minutes from the latest Fed meeting suggest that some officials indeed think the program will have to keep going…

Schwarzenegger seeks U.S. funds (Woo/Carlton, WSJ) He says the nation’s taxpayers owe California money…

H&M says it will no longer destroy unworn garments (Dwyer, NYT) Jim put a good article in yesterday’s Times criticizing H&M for this practice. They responded quickly.

Lucky climbers (YouTube) Watch all 29 seconds…

Puppy glasses…

I have a treat to share with readers. Warren Mosler and Jim Rickards have agreed to an op-ed debate here on my blog. Over the course of a couple weeks, they’ll engage in intellectual fisticuffs about how to fix the economy.

Who are these two and why do you care what they have to say?

First, they’re both very smart and well-informed.

Mosler, who moved to St. Croix in 2003 to run for Congress in’04, ran a fixed-income arbitrage fund for 15 years without, he claims, a single losing trade. He turned it over to his partners in 1998 with over $3 billion of capital. He’s the progenitor of some of the derivative products traded today and even has his own ultra-cool car company.

Rickards, once upon a time, was LTCM‘s general counsel and the principal negotiator of the hedge fund’s NYFed-sponsored rescue. So when he talks about the dangers of leverage, he knows from where he speaks. Today he’s the economics expert for national security consulting firm Omnis and applies concepts from physics to his analysis of the economy.

Also they’re both very provocative. Mosler’s Law is that “there is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.” Rickards sees a “high degree of probability that gold goes to $2,000 by the end of this year.”

I wanted to give these two a forum because grappling with provocative, well-informed opinions helps keep us all honest.

Look for the first pieces tomorrow or Friday.

Economist Kevin Kliesen at the St. Louis Fed asks that question in an article he published today.

In its 2009 Annual Report, the Bank for International Settlements discussed these “bubble-induced distortions” to current estimates of trend output growth and, hence, potential real GDP. Thus, it is conceivable that estimates of potential real GDP at the start of the recession were too large and that … structural adjustments … may have subsequently reduced potential real GDP from its artificially high level.While it is probably unlikely that the fall in actual real GDP during the recession has been matched by the fall in potential real GDP, the size of the output gap might be smaller than conventional wisdom might believe. If so, those who foresee little risk to the near-term inflation outlook because of a large, persistent output gap may be too optimistic.

Krugman Keynesians argue that the output gap restrains wage-push inflation and therefore the Fed and Treasury can stimulate without fear of sparking inflation so long as the unemployment rate is high.

But what is a high unemployment rate? Just as output was goosed by the credit bubble, so too was employment.

Kliesen argues that Bernanke has less room to maneuver than he thinks.

Let them eat lobster! (Yves, Naked Capitalism)

The weather according to economists: sunny! (Kedrosky) Group think…

How to combat the natural tendency to procrastinate (Economist)

Let’s get fisical (Bill Gross, PIMCO) In his latest investor letter, Bill Gross paradoxically laments the influence of special interests. Of course he was one of the chief special interests — representing the investor class — lobbying for government to support asset prices. He also questions how the market will perform when our government “sugar daddy” disappears, especially in light of the disappearance of foreign buyers of Treasuries.

Snowed-in Brits boost adultery website (Casciato, Reuters)

Create your own solar system (Colorado.edu) Click “Run Now” and then play with the variables bottom left.

Dubai starbucks (imgur)

Three-toed sloth on ride of his life…

The big news today comes out of Washington where Senator Chris Dodd, Chairman of the Senate Banking Committee, is expected to announce he won’t seek re-election in November. (Ferraro, Reuters)

The news, coupled with another Democrat’s retirement announcement [Byron Dorgan of North Dakota], underscored the fragility of the Democrats’ Senate majority, which is just enough to push President Barack Obama’s agenda past Republican procedural obstacles.

Dodd’s retirement doesn’t mean Dems will lose the seat. Richard Blumenthal, CT’s very popular attorney general, will likely win it.

The aides offered no reason for Dodd’s decision, but it had been clear for months the Democratic lawmaker from Connecticut, dogged by questions over his financial industry connections, had faced the prospect of being voted out of office.

His participation in the Friends of Tangelo program is the issue here.

It remains to be seen how Dodd’s withdrawal from the race will influence how he handles two major jobs in the Senate this year — one as chief steward of financial reform and the other in the healthcare debate.

The House has passed its version of financial reform, but the Senate version is still in Dodd’s committee.

From the Mortgage Bankers Association’s Quarterly Data Book:

Avatar’s $1 billion in ticket sales is getting all the headlines, but Fox’s other holiday film, “Alvin and the Chipmunks: The Squeakquel”, may be more valuable to Rupert Murdoch  over the long run.

While Avatar packed them in, the latest Chipmunk offering surpassed the quarter-billion dollar mark despite poor reviews and heavy competition. Indeed the Chipmunks demonstrate the importance of franchise value to the movie business.

Alvin, Simon and Theodore have been around since 1958, inspiring TV shows, hit songs and two feature films. The first film grossed $361 million at the worldwide box office while the second is already up to $255 million after just 12 days in wide release. Ancillary revenues like DVD and lunchbox sales could add millions more.

For investors, who prefer recurring profits and low risk to big bold bets on potential blockbusters, this is pay dirt. Like Spider-Man, Harry Potter or Batman, there is a long-term revenue stream attached to the Chipmunks. It’s partly why Disney – with its focus on princesses, pirates and now, with Marvel, superheroes – commands a higher multiple of earnings than many rivals.

Avatar has great franchise potential as James Cameron says he’s thinking of making it a trilogy. But the 55-year old director has yet to write a second script. And with the first film such a success, he may command an even larger ownership stake in any sequels.

If Avatar is a one-off, its value to Fox may not be much beyond $100 million (and counting) of additional operating profit according to JPMorgan estimates. But multiply by five the $40 million the Squeakquel will squirrel away, to reflect the likelihood the franchise will endure, and three 50-year old Chipmunks trump Mr. Cameron’s Na’vi.

Must Read–Global bear rally will deflate as Japan leads sovereign bond crisis (Evans-Pritchard, Telegraph) Points to Ambrose for making lots of predictions in a single column! (ht Yves)

How Visa, using card fees, dominates a market (Martin, NYT) A good, detailed article. Merchant processing fees aren’t the terrible thing merchants claim them to be. The trade-off, at least with credit cards, is that the merchant doesn’t carry a receivable on his balance sheet. There’s no credit risk that customers won’t pay. This article is about debit cards, however. There the issue appears to be much more complicated…

Iceland president vetoes compensation for depositors (Forelle, WSJ) Great article with lots of nuggets of information. On the one hand Icelanders don’t want to be put into debt slavery to pay off obligations of their failed banks. On the other hand, they need foreign currency to support international trade. They can’t get it while they’re an international financial pariah. Tricky. But walking away may be the best option…

Politico crushing it on revs (Ali, PaidContent) A $1 million operating profit for a news property is solid performance in this environment. Good piece, but hopefully Rafat can design more legible spreadsheets in future…

Net national savings rate still negative (Mike Mandel, ht Felix) This chart effectively shows the decline in America’s balance of trade over time. It will take a far deeper correction to change the trade dynamic of the West sending paper currency to the East in exchange for its goods. That’s great for us as long as it lasts. But it won’t last forever and the correction will likely be very painful.

Pending home sales crater (NAR) The title of the press release is interesting: NAR tries to spin as good news the fact that pending home sales dropped sharply after being inflated by folks rushing to capitalize on the first time homebuyers credit (which they didn’t know would be extended).

ESPN, Discovery launching 3D networks (Szalai/Hibberd, therfeed)

Refreshing beverage (imgur)

The man who is good at everything…

Finally got around to watching this video. Kudos to Gerry Levin for taking responsibility for the worst merger in history. His comments about banks being malls instead of supermarkets is very true, but it’s not his, it’s Chris Whalen’s, who provided a helpful counterpoint in NYT’s non-mea-culpa from Sandy Weill. Their point is that the synergy Sandy Weill claimed for Citigroup — combining insurance with commercial banking with investing banking with retail brokerage, etc. — was bogus from the start.

Of course Sandy doesn’t have it in him to admit he was wrong. Instead he blames his successor Chuck Prince. Another CEO who got away with blowing up a company was Merrill’s Stan O’Neal. John Thain has taken heat for his time there, much of it he probably deserves for his ridiculous office redesign and for extracting bailout money to fund Merrill’s bonus pool. But O’Neal is the guy that deserves the blame for Merrill’s collapse. He got his golden parachute and disappeared.

Shareholder activism is a tactic typical of Carl Icahn, not the Oracle of Omaha. Yet Warren Buffett has issued a press release asking other Kraft shareholders to reject Kraft’s proposal to use up to 370 million shares of stock to buy Cadbury.

To state the matter simply, a shareholder voting “yes” today is authorizing a huge transaction without knowing its cost or the means of payment.

What we know with certainty, however, is that Kraft stock, at its current price of $27, is a very expensive “currency” to be used in an acquisition. In 2007, in fact, Kraft spent $3.6 billion to repurchase shares at about $33 per share, presumably because the directors and management thought the shares to be worth more….

Rolfe here. Buffett argues that KFT stock is an “expensive” acquisition currency because he thinks the shares are worth more than $27. He has a special history on this, as I get to below…

Would the directors use stock as merger currency if the price were, say, $20 per share? Surely the true business value of what is given is as important as the true business value of what is received when an acquisition is being evaluated….

At this time…we believe no shareholder should vote “yes” when he can’t possibly know what he is voting for.

Buffett is famous for his hands off approach to management. He invests in companies as much for the franchise value as for the folks running the business. That’s because management is often the crucial variable to generating value over the course of the business cycle.

But Buffett REALLY hates to use stock to pay for acquisitions. Here’s an instructive passage from his ’07 shareholder letter:

Finally, I made an even worse mistake when I said “yes” to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that’s just the beginning: By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.

For those that don’t follow: 25,203 shares of Class A Berkshire stock are today worth far more than the $433 million they fetched in 1993. In the fullness of time, as BRK stock has risen, the Dexter purchase price has ballooned 10x.

Buying a business with stock that’s going up gives the seller more value over time. It’s tantamount to selling the stock yourself, which doesn’t make sense if you think it’s worth more.

Conversely you have an example like Steve Case, who brilliantly sold all of AOL’s overvalued stock to Gerry Levin in exchange for Time Warner’s great media assets.

On another note: Is Buffett getting sloppy in the credit bubble age? He paid up for Burlington Northern (28x FCF!), even admitting that the price paid was pretty high.  His purchase of Kraft shares also at a high valuation similarly left him with little margin of safety.*

He got lucky on BUD, finding greater fool InBev to pay a premium to the high price he paid for the shares.

Appears that in the age of low rates and overinflated valuations, Buffett has no choice but to chase risk with the rest of us.

By the way, this is not to argue with the fact that Buffett was the 20th century’s best investor. I believe firmly that he was. To me, his value methodology, when properly applied, is the dictionary definition of “investing.”

Trouble is, it seems to me he’s no longer able to apply it in the age of overinflated assets…

—–

*Buffett bought his KFT shares near the end of 2007 for an average price of about $33.40. Today the stock is near $28. $33 per share implies a $67 billion enterprise value for KFT today. Forward unlevered FCF when Buffett bought his KFT shares (that is, for 2008) ended up at about $3.8 billion, implying a valuation of 18x EV/UFCF. Cheaper than the Burlington deal, but a rich multiple nonetheless.

Living on nothing but food stamps (Deparle/Gebeloff, NYT) The safety net of last resort: 2% of U.S. households report zero income other than a food stamp card.

Twenty years on Japan is still paying its bubble era bills (Economist) Heard on the Street also writes today that Japan is looking at its third consecutive lost decade. Copious amounts of deficit spending and money printing hasn’t worked for Japan. It won’t work for us.

Petition halts Iceland’s repayment plan (UPI) Icelanders want bank creditors — in this case foreign depositors — to eat the loss of bank failures. Probably sensible. Depositors were foolish to chase returns in Iceland to begin with. Putting Icelanders into debt slavery to pay them off does little good.

Lessons learned but not applied (Simon Johnson) Summers/Geithner know the right prescription to handle bank failures. They just aren’t willing to follow it themselves… (ht Walker Todd)

Real estate in Cape Coral is far from recovery (Goodman, NYT) Another foreclosure tour. Notes that busted homeborrowers often leave lots behind when ditching their house. See again: trash-outs.

The year in Review (Doug Noland) Skip to the last section at the bottom. Reader Paul M. points to Doug’s comment that healthy corporate leverage ratios are misleading because their customers (and the system in general) are still leveraged to the hilt.

Australian lotto winner keeping it real (Paddenburg, Couriermail)

Beautifulpeople.com axes holiday weight gain members (BBC) Quotable from the founder: “Letting fatties roam the site is a direct threat to our business model…” Wow.

10 sci-fi weapons that actually exist (Wired)