Notes for the Week — December 21

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I’m reviewing the news from the week.  The key points are below.  You will notice that I have tried to relay key data…as that tends to be one of my big interests.

Obama needs to apologize for comment. Last week, Obama said, “I did not run for office to be helping out a bunch of fat cat bankers on Wall Street.”  This comment was degrading to fat cats.

Bernanke has been saying “for an extended period” for…an extended period. The FOMC has stated that they would maintain low interest rates “for an extended period” SINCE…

The Fed has effectively wound down several programs. Emergency short-term discount window loans have dropped from $100 billion to $19 billion; Fed purchases of commercial paper have dropped from $350 billion to $15 billion; loans to foreign financial institutions (via foreign central banks) have dropped from $500 billion to $17 billion.

It may be difficult for the Fed to sell the mortgage backed securities in their portfolio. This could hurt the housing market.

Job creation over deficit reduction. White House economic advisers made comments indicating that creating jobs will be considered to be more important than reducing the deficit.

The Federal debt limit will provide an easy battle ground. The debt limit has to be increased from $12.1 trillion in order to avoid default.  While we will eventually do this, it’s an easy place to make your argument against the deficit.

Prepping for inflation. So far this year, $59 billion has flowed into funds that invest in Treasury Inflation Protected Securities (TIPs) and gold.  At the same time, $52 billion has flowed out of US stock funds and ETFs focused on US stocks.  Some investors are also considering staples and commodities.

Abu Dhabi steps up. Abu Dhabi is giving $10 billion of support to neighbor Dubai.  This will allow repayment of the $4.1 billion bond that was expected to default.  Apparently, Dubai and Abu Dhabi were both surprised at the ferocious negative reaction the financial markets had given to Dubai’s earlier announcement of problems.  This $10 billion pledge does not solve the problem of Dubai’s $100 billion of debt backing many failed projects.

TARP money returned. Including Citi, banks have returned $161 billion of the $245 billion loaned to them.  Much of the unpaid money is at GM and AIG.

The current M&A market is still weak. Approximately 87% of middle-market private equity investors said that the current M&A environment is fair or poor.  Activity was 1/3 lower in 2009 than 2008.  Strategic buyers (as opposed to financial buyers) have accounted for 94% of deals.  Multiples for middle market deals have fallen from 10.1X EBITDA (in 2007) to 8.4X EBITDA today.  The respondents said they expect to pay no more than 5X EBITDA in the coming months.  The investors said that there is a disconnect between buyers and sellers (sellers are looking at historic multiples).  On a positive note, they said that debt markets continue to improve and that deals would require a larger equity investment.

Citi paid back $20 billion.  Citi will repay the $20 billion that the government loaned them in the form of preferred stock and will unwind the government’s insurance of $301 billion of assets.  The Treasury is also selling its 34% position over the next year.  This deal was made possible by an IRS ruling that apparently allowed Citi to maintain a multi-billion tax benefit that they might have lost by the Treasury selling their shares.  I have not read about this issue, but many people feel that this was just another taxpayer subsidy (and it’s the perfect type — since none of us understand it).

Don’t forget that the government has given the banks a huge continuing subsidy.  It’s easy to hear of the TARP repayment and think that the banks have solved their problems.  In reality, the government solved the banks’ problems — which means that you and I have paid for it.  The government bought more than $1 trillion of mortgage backed securities which did three things:

1. allowed banks to make loans without risk

2. kept interest rates low (favorable for banks)

3. allowed banks to earn trading profits, as the government signaled their huge purchase

On second thought…I don’t want to sell.  Stanford had been trying to sell $5 billion of partnership interests.  They decided to hold these securities.  This reflects low bids, improved public markets (lessening Stanford’s liquidity issues) as well as Stanford’s optimism for the future.

The most ignored compensation.  The WSJ did an article on deferred compensation plans for executives at many companies.  These plans allow executives to invest amounts greater than the $16,500 limit on 401(k) plans.  Some of these deferred compensation plans have fixed return options that can range all the way up to 12%.  A fixed rate of return of 12% is pretty nice, considering the ten year Treasury yield is 3.6%.  About seven years ago, I used to talk about these plans in class and I argued that these were going to become a huge issue in the following five years.  Again, they are too complex and receive too little attention — so the story doesn’t get traction.

Boo hoo hoo. AIG’s CEO said that ten people who report to him have lost $168 million in prior years’ pay.  You work at a company that almost destroyed our financial system and you didn’t get rich.  We live in such an unfair country.

We live in a nation of morons. A survey showed that 79% of Americans favor central bank audits.  Maybe we should also start electing the Fed governors and people could run with campaigns promising to keep rates low.

The difficulties of unemployment.  A NY Times / CBS poll of 708 unemployed people showed:

1. over half had borrowed money from friends / relatives since losing their job

2. approximately 40% have seen behavioral changes in their children that they attribute to the parents’ job situation

3. approximately 25% said that they had either lost their home or threatened with foreclosure or eviction

4. approximately 25% have received food stamps

5. approximately 70% described their family’s situation as fairly bad or very bad

6. 55% have suffered from insomnia

7. almost 50% said that they feel embarrassed or ashamed most of the time or some of the time for being unemployed

8. nearly half said that they did not have health insurance

We’ve shifted all of the burden to Fannie and Freddie.  Fannie and Freddie’s regulator (Fed’l Housing Finance Agency) is considering asking for an increase in their $400 billion government credit line.  So far, they have used $111.6 billion.   Over the last nine quarters, Fannie has lost $120.5 billion and Freddie has lost $67.9 billion.  Fannie and Freddie own or guarantee $5.5 trillion of the $11 trillion of US residential mortgage debt.

Recovery in leveraged loans.  Leveraged loans have returned 49.3% this year, after losing 28.2% in 2008.  Leveraged loans can be thought of like “junk” loans — they are rated below BBB.  Collateralized loan obligations (where loans are put into a portfolio and divided into tranches) is a $440 billion market.  JPM, BAC and C are apparently talking to originators about starting more CLOs now that they have had a good year.  CLO sales were $32 billion in 2004, and reached $100 billion in 2006 and 2007.

My how things change.  The Chairmen of Goldman Sachs, Morgan Stanley and Citi called in for a meeting with the President rather than showing up in person.  The problem was bad weather and the three callers apparently apologized profusely.  Some commentators took this as a signal that the White House no longer controlled these firms.

If you owned a radio station, is this how you would run it? Is it just me (aka Scrooge)…who thinks it’s a good idea to play nothing but Christmas carols starting the day after Thanksgiving and going through December.  My guess is that the Supreme Court wouldn’t allow us to do this to the prisoners at Guantanamo.

How do you expect companies to think about the long term when banks apparently can’t survive if they don’t pay bonuses this year?

Sovereign wealth funds lost approximately $600 billion in the past two years.

Examine how much banks lost by selling stock at these low prices. C sold new shares at $3.15.

Brian Moynihan was selected to replace Ken Lewis at BAC.

Taxpayer money is being used to support AIG, Fannie and Freddie and this is basically protecting investors and banks who own these mortgages.

Do we have a long term shift to being more thrifty.  Look at Commerce Dep’t savings rate increase.  Do you want to sell BMW type stocks?  In October, Americans saved 4.4% of their disposable income.  Over the past ten years , this has averaged 2.7%.

Leading economic indicators rose .9% last month, the eighth consecutive monthly increase.  Personal income grew .3% in Q3.  Nineteen states experienced income growth for the first time in a year.  The number of workers filing new claims for unemployment benefits rose 7,000 to a seasonally adjusted 480,000.

WSJ / NBC poll found:

1. 33% said America is headed in the right direction (down from 42% in June)

2. 46% said 2010 would be better for the country than 2009

3. more than 40% said that they think it is extremely likely that they will either lose a job, have their wages cut or be forced into a lower paying job in 2010

4. approximately 25% expect to simultaneously lose income while also having to aid family members

5. approximately 2/3 said that America is in a state of decline

6. approximately 2/3 said that the are not confident that their children’s generation will be better than it has been for their generation (interestingly, these numbers were similar for both the upper and lower class)

7. 39% said that China would be the world’s leading nation in 20 years (37% thought it would be the US)

8. approximately 20% of professionals are dissatisfied with their job security

States have cut $55.7 billion from budgets but still have a deficit of $14.7 billion.  States general fund spending is expected to decline 5.4%, the sharpest drop since this data has been collected (1979).  States have also enacted the largest tax and fee increase on record ($23.9 billion).

The US represents 30% of the world’s stock market capitalization.

Steep yield curves occurred in August 2003 (274 bp difference between two and ten year UST) and 262 bps in July 1992.  The new record was just set at 276 bps.

Fed could affect short term rates (as usual) or long term rates by selling assets.  How will the $1 trillion of excess reserves affect policy?  Some think that the Fed will have to raise rates faster due to the excess reserves.

Buffett had great comments about gold.  He said that we dig it out of the ground in Africa, melt it down, sell it, bury it in another hole and then pay someone to guard it.  It doesn’t make a whole lot of sense.

Chinese IPOs raised double the amount that the US raised in 2009.  The US raised $26.5 billion.  Hong Kong alone raised $27.2 billion and mainland China raised $24.4 billion.

Moody’s upgraded the housing market to “stable” for the first time in four years.  This was prompted by rising sales and affordable prices.  Spreads on homebuilder debt (above UST) have narrowed to 8.5%.  Last December, they hit 25%.  Prior to the crisis, they had average 2.9% (in 2006).

The unemployment rate fell in 36 states. Last month 52,000 temporary workers were added — the largest category of job gains.

North American theaters have generated $9.95 billion of ticket sales this year. Attendance was 1.39 billion, already 3% higher than last year. But, this is 12% below 2002, the peak attendance year of the decade. There were 14% fewer films released (vs. 2008). But 3-D sales have been approximately $1.3 billion. This is approximately $1 billion higher than 2008. There are now 440 Imax theaters around the world, 24% higher than last year. Avatar cost $310 million to produce.

The total bank losses for all loans and securities in euro zone banks from 2007 to 2010 is now estimated to be $796.6 billion. This estimate is approximately 12% higher than previous estimates.

S&P has downgraded Greece to BBB+. Moody’s still has an A rating on the country’s debt.

Five of the ten largest subprime lenders during 2007 were banks regulated by the Fed.

Many economists were referring to the smaller and less frequent downturns as “the great moderation.”

In general, banks must hold $10 of reserves for every $100 of assets.  But, the Fed (and other regulators) decided (in 2001) that they only needed $5 of reserves for investments in pools of loans.

The Fed had shifted to examining risk management proceduers, rather than actual transactions.

Fed approved Wachovia’s purchase of Golden West.  Several analysts had warned the Fed of the danger involved.  Wachovia was eventually sold to Wells Fargo.

Copper continues to rise, even in the face of the strongest dollar in three months.  Japan’s drop in exports was the lowest in 14 months — signaling recovery.  Investors are more worried about Europe than the US.

In 1984, the core-CPI increased 5%, even while unemployment was near 7%.

From the day after Thanksgiving through December 12th, internet sales were 14.4% higher than last year.

Since April, BAC’s outstanding loans to small businesses decreased 5% to $2.2 billion.  JPM’s dropped 2.5% and WFC (the largest lender to small business) dropped $3 billion.

Nearly 1,500 funds (16% of the total) shut down last year.

In 200 years of recorded history, the 2000s will rank as the worst decade.  Since December 31, 1999, investors have lost approximately .5% / year.  The 1990s gave an average return of 17.6% / year.  The ten year periods ending in 1937 and 1938 were worse, but we are looking at round decades.  Bonds returned 5.6% to 8% per year, deending on the type.  Gold increased 15% / year after losing 3% / year in the 1990s.  The stock market’s returns were even worse if you adjust for inflation.

Maybe we’ve seen a large change in stock returns.  Dividends have been replaced by share repurchases.  But the number of shares has not decreased — it’s going to executive compensation.

Treasury dealers are forecasting higher interest rates.  They expect the two year note to rise to 1.825% by the end of 2010 and the ten year yield to reach 4.125%.  Recently, the two year yield was .8% and the ten year was 3.55%.  The government is expected to issue more debt, raising $1.4 trillion this fiscal year, after selling $1.79 trillion of debt in the FY ending last September.

S&P 500 corporate pension funds lost about 27% of their assets ($400 billion) last year.  It is estimated that the pension deficit for these companies is currently $270 billion.  Companies are going to have to make contributions to close this deficient over the next seven years.

Japan is keeping interest rates low to fight deflation (and that is hurting the yen).  Investors are worried about weakness in the euro zone.  Investors are starting to do the carry trade in Japan again (rather than the US).

Steep yield curve shows investors selling government bonds and buying equities.  Spread is good news for banks.  Spread reached 2.81% (between 2 yr and 10 yr).  Last year, the spread was 1.27%.  In June 2007, it was inverted.

Redefaults are slowing.  Approximately 18.7% of loans modified in Q2 of 2009 were at least 60 days past due three months later.  The average for the prior year had been 30%.  Monthly payments have dropped by 35% for people in the Obama program.  Overall, 6.2% of loans were at least 60 days past due in Q3, a 17% increase from Q2.  Approximately 3.6% of mortgages made to borrowers with good credit ar 60 days past due.  This was 3% in the prior quarter.

The market for prepaid cards grew to 247.7 billion in 2008 from $220.3 billion in 2007.