Market Update — July 21

Market Update – July 21

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Hi All,

I’m prepping for two presentations that I’m giving this week.  I’m mostly talking about our debt problems.  But, I spent a few hours today making notes from newspaper articles from the last week.  The articles are generally those that involve debt, taxes, states, budgets, etc.  In other words, these are newspaper articles related to all of the issues that I’ve been thinking about lately.

Below, you will find a summary of those articles.

Enjoy.

Sandy

The Situation is Dire

1. Greenspan said that “unless we start to come to grips with this long-term outlook, we are going to have major problems.  I think we misunderstand the momentum of this deficit going forward.”  He also said that reducing the deficit “is going to be far more difficult than anybody imagines after a decade of major increases in federal spending and major tax cuts.”


2. The two leaders of President Obama’s Debt Commission (former Republican Senator Alan Simpson and President Clinton’s Chief of Staff Erskine Bowles) made some dire comments about our situation.  Bowles said that Social Security, Medicare and Medicaid fully consume federal revenue.  Everything else (fighting two wars, homeland security, education, art, culture, veterans, etc.) is being financed by China and other countries.  Bowles also said that we can’t grow our way out of this problem and that the debt is a cancer.


3. Here’s a good chart from The Washington Post showing what our budget looks like. (SOURCE: White House Office of Management and Budget; GRAPHIC: Wilson Andrews, Jacqueline Kazil, Laura Stanton, Karen Yourish – The Washington Post)

Federal Budget

5. One of the big issues right now is whether we should let President Bush’s tax cuts lapse.  In order to get the cuts passed in 2001, Bush agreed that they would lapse in ten years.  Recently, Alan Greenspan said that we should let them lapse in order to cut the deficit.  He said that while this may slow the economy, the threat of the deficit is larger.  President Obama says that we should continue the tax cuts, except for those making more than $250K.


6. We spend too much time worrying about our “tax gap” – the gap between what we should collect and what we actually collect.  We’re all outraged by tax evasion.  But the reality is that it’s going to happen.  In 2012, businesses are going to have to start filing documents with the IRS for every vendor from which they buy more than $600 of goods and services from.  This will be a paperwork nightmare.


Politicians Are Horrible

7. The House has not passed a budget outline for the first time since 1974, when the current budgeting system started.  These budgets list revenues and expenditures for the next five years and allocate money to large categories (such as defense).  One of the problems is that many Democrats are facing tough campaigns – so some of them want to cut spending and others don’t.  The only resolution that the House passed is one which says that discretionary spending will be $1.12 trillion.  Republicans are placing ads saying that this is evidence that Democrats have no priorities and they can’t control spending.  Democrats are taking credit for the pay-as-you-go law that requires all new spending to be offset by cuts and by arguing that the Republicans got us into the financial mess.

Our International Problems

8. China’s State Administration of Foreign Exchange (SAFE) said that it would not use China’s foreign exchange investments as an “atomic weapon.”  China has reserves equivalent to approximately $2.45 trillion.


9. The IMF said that Europe’s weak economy is the central threat to global recovery.  The countries struggle with heavy debt, banks have low capital and growth is slowing.


The Global Economy

10. According to The Economist, the IMF identified some downside risks to the global economy: banks could curtail lending because of their exposure to impaired government debt, consumers and businesses could spend less because their confidence has been dented, deficit spending could suppress new growth, new financial regulations could damp bank lending, American property prices could fall further, and exchange rates could go haywire.


11. Apparently, the Fed is thinking about what to do in case our economy weakens.  One idea is to strengthen the language so that investors know that we’ll be keeping rates near zero for even longer than we already expected.  Another idea is to stop paying interest to banks for excess reserves – so there is more incentive to loan those funds out.  Another idea is to keep buying mortgage backed securities (as those that the Fed owns are paid off).


Other Countries Have Debt Problems

12. The amount of debt of many of the large economies is growing at a much faster rate than developing markets.  From 2007 – 2010, the US and Japan have increased by approximately 30% and the UK has increased by 36%.  Germany increased 37.7%.  Germany only increased 12%.


13. Interestingly, the UK is preaching austerity while the US is still spending.  The difference is that the UK’s new government has time while the US has upcoming elections.


14. Britain announced this week that their debt is approximately 4 trillion pounds – approximately four times higher than previously announced.  This total includes “off-balance sheet” liabilities – primarily public sector and state pensions.  Their National Institute of Economic and Social Research said that taxpayer should be paying approximately 30% more in tax in order to avoid passing the burden to the next generation.


15. S&P has told the UK that they are at risk of losing their AAA rating, despite their austerity measures.


16. Moody’s cut Portugal’s sovereign-debt rating two notches to A1.  In April, the Portuguese government announced their plans to cut their budget deficit from 9.4% of GDP (2009) to 8.3% in 2010 and 2.8% in 2013.  S&P already had Portugal rated A- with a negative outlook.  Fit rates them AA- with a negative outlook.


17. Spain just issued $3.8 billion of debt at 5.116%.  The market seems willing to buy risky sovereign debt.  One possible reason is that the US recovery doesn’t look particularly strong.


18. The EU is discussing how to encourage member nations to index retirement age to increasing life expectancy.


19. The global imbalances which were supposed to be corrected by the recent financial turmoil are back in full force.  China, Japan and Germany continue to have huge exports, save too much and spend too little.  The US, Britain and other European nations tend to import, save too little and spend too much.


Debt Issuance Will Be Huge

20. The IMF pointed out that European countries and the US will be competing to refinance $4 trillion in government bonds maturing in the second half of the year.


21. The US will sell approximately $2 trillion per year for the next two years.  This is a combination of refinancing and deficit issues.


22. Sovereign debt will have to compete with financial institutions.  Banks worldwide owe nearly $5 trillion to bondholders and other creditors that will come due through 2012.  Approximately $2.6 trillion of the liabilities are in Europe.  US banks must refinance $1.3 trillion through 2012.  The European debt is the bigger issue because the banks haven’t cleaned their balance sheets as well and are loaded down with sovereign debt that investors are worried about.


23. Bond issuance by financial institutions in Europe dropped to $10.7 billion in May.  In May 2009, it was $95 billion.  In January, it was $106 billion.  May was a time of crisis (with Greece) and the market seems to be recovering.


24. S&P said approximately $1.7 trillion in bonds are due in the next three years among the non-financial companies that it rates.  Much of this is not investment grade.


Municipal Debt and States

25. Thirty-five municipal bond issues (totaling $1.5 billion) defaulted in the first six months of 2010.  This is three times the typical rate but better than recent years.  Last year, 194 municipal borrowers defaulted on $6.9 billion of bonds.  In 2008, 162 issues defaulted on $8.2 billion of bonds.  The prior two years were impacted by Jefferson County (Alabama) and Lehman (which was not able to pay back on some Georgia bond guarantees).


26. On June 30, the cost of credit default swaps on municipal bonds hit $266,500.  This was the highest level since March 2009.  But, by July 15, this was back down to $223K.


27. Commercial banks hold $216.2 billion of municipal debt.  If there is downward pressure on these bonds, these banks will be hurt.  Municipalities are hurt by unemployment and dropping real estate prices.  Warren Buffet predicted a “terrible problem” for municipal debt when testifying before the Financial Crisis Inquiry Commission.  Lenders hold approximately 8% of the $2.8 trillion state and local government debt market and muni bonds are only about 2% of total bank assets (which makes them approximately 25% of capital).


28. Connecticut has been encouraging hedge funds to move from NY to Connecticut in order to avoid NY taxes.  NY is planning on taxing the carried interest of NY based hedge fund managers (who live out of state) at the top ordinary state tax rate.


29. Maywood California has fired all of their workers and outsourced everything.  Much has been outsourced to nearby cities.  Many city employees have been rehired as contract workers.  But, the 30,000 resident city is lowering costs.


Random Stat

30. Interesting stat: approximately one in seven homeowners with loans in excess of a million dollars are seriously delinquent.  Only one in twelve mortgages below the million-dollar mark is delinquent.  The delinquency rate on investment homes where the original mortgage was more than $1 million is now 23%.  For cheaper investment homes, it’s 10%.

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