Don't Tread On Me » Dana Meador

Fed Printing – It’s All About The Banks

Dana Meador — Thu, 23 Aug 2012 01:48:14 +0000

In an investment environment where companies must show compounding earnings each successive quarter, without the Fed and Helicopter Ben printing money the banks would be is serious trouble. Here’s why:

In the past 5 years banks have made money in the following ways:

1) Borrow short, lend long. As long as the banks’ cost of credit is virtually zero, they make money on the spread. In 2008, 30 year mortgages were initiated at 5-6% interest, now they are initiating at 3-4%. Each successive quarter, banks are earning less on performing mortgages but the spread is still positive and they are making up the difference on mortgage origination fees.

2) Proprietary trading. Since 2008, the stock market has more than doubled and been quite volatile to boot. The Dodd-Frank legislation provisions regarding proprietary trading have not yet hindered banks from making large profits buying, holding, and also trading volatility. Derivatives have, for the most part, worked in their favor.

3) Holding treasuries and other credit instruments. As long as credit yields are trending downward, banks make money on the credit instruments they hold on their books (the market value of existing obligations go up as yields go down).

4) Releasing loan loss reserves. As long as the economy looks like it’s improving, banks are permitted to take into income a portion of the allowance for bad debts they accrued in 2008. (This has been a huge contributor to bank earnings over the past 5 years.)

5) Mergers, acquisitions, and IPOs. When the economy is stable, banks make huge fees structuring and underwriting deals. While this revenue is nowhere near what was made in the heyday of the 80s and 90s, it is still a factor in the overall profitability of a bank.

Without Central Bank intervention, most (if not all) of the above would not just lessen but reverse! Let’s see how:

1) Borrow short, lend long. Without Central Bank intervention, interest rates would find their true, risk adjusted value. People who locked in 3-4% loans for long periods of time would count themselves lucky, while banks would take a hit on the spread. Indeed, even with Central Bank intervention, banks will not make as much in this category as they have historically, due to the lower zero bound, where interest rates simply cannot go any lower. From here on out, without Central Bank intervention, the risk of yield curve inversion is quite high. Also, when interest rates begin to creep up, refinancing dries up and with it the fat origination fees the banks have gotten used to (Just last week new mortgage applications were down 7% as interest rates have been trending sharply higher in the past month).

2) Proprietary trading. As JPM’s $5 billion derivatives “hiccup” proved, banks don’t do well on these type of investments when the worm turns (especially if it turns quickly and they are on the wrong side of the trade). The “new normal” cited by Bill Gross of PIMCO, is death to a bank’s prop trading profits. There must be volatility, preferably to the upside, for banks to continue to make as much money as they have in the past. Without the hopium provided by Central Bank intervention, the risk is to the downside.

3) Holding treasuries and other credit instruments. Interest rates must be held down or the credit instruments the banks hold will go down in value. While the banks no longer have to mark these instrument to market, they have counted on price appreciation to accrete earnings. (As a corollary, banks don’t lend as readily when interest rates are rising. If they do, it’s at variable rather than fixed rates. This in turn hurts the recovery as both the cost and availability of credit goes down.)

4) Releasing loan loss reserves. Without Central Bank intervention, all hope for growth in the economy and new jobs (justification for releasing reserves) would evaporate. Not only would banks not be able to release additional loan losses as profit, but they would very probably have to initiate an increase to their loan loss reserves, which would be a drag on profits.

5) Mergers, Acquisitions and IPOs. Fees would dry up virtually overnight. Nobody does deals when the economy isn’t growing.

In short, it’s really all about the banks. The Fed has to keep the banks liquid and profitable at any cost. So far, just the promise of future easing has kept the hounds at bay. Soon, however, it will require real infusions of liquidity to keep interest rates moving downward and the stock markets moving upwards. Without it the banks are, in a word, screwed.

Looking for Liquidity in the Couch Cushions

Dana Meador — Fri, 22 Jun 2012 20:40:56 +0000

Today the ECB announced that it was “expanding loans eligible for participation” in the $1.2 billion LTRO program it began in December 2011 and expanded in February 2012. To refresh the facts for those unfamiliar with the LTRO, European banks are being permitted to pledge collateral (aka non-performing loans) in exchange for cash at an interest rate of 1% fixed for three years. 500+ banks took the ECB up on the offer, pledging over 4,000 different types of loans to the ECB in exchange for cash. But liquidity for the periphery banks is still a problem, so today the ECB expanded the qualified loans to include car loans and commercial and residential mortgages (of which Spanish banks in particular have tons).

The problem with balance sheet expansion that is supposed to be temporary (in this case a 3 year duration) doesn’t come when giving out the money. It comes when getting it back. Uniformly, PIIGS banks have used the debt to help kick their countries’ cans down the road, using LTRO to fill in the gaps in sovereign bond issuance and pay down other liabilities (Spanish banks took $195 billion in LTRO and Italy took $114 in LTRO and they used $102 and $73 respectively to buy government bonds**) But what happened to the rest of the liquidity? God only knows, but I personally suspect that much of the beyond the pale volatility we are seeing in the US market (particularly when companies announce news of any kind) is a function of misplaced use of funds by banks desperate to double their money before the three years expire. These 15-20% swings in market cap on relatively benign news IS NOT NORMAL (ex Amazon, Bed Bath and Beyond, Ryder, Dardin, etc). Nor is a 10 year US treasury rate of 1.5% normal in any way. Unquestionably, ECB generated liquidity is finding its way into the US markets and is creating the kind of volatility that scares the pants off individual investors and adrenaline rushes in day traders. It may be banks using their prop trading desks to trade, or banks lending money to hedge funds to trade. Either way, the US, Germany, Switzerland and even Japan are awash in both ECB and fleeing depositor liquidity while the periphery countries are stuck looking for liquidity in the couch cushions.

**Source Bridgewater Capital

The Great Asset Grab – What’s the Score?

Dana Meador — Wed, 20 Jun 2012 17:26:53 +0000

In a Marketwatch article this morning, Caroline Henshaw provided a tally of the score in the Great Asset Grab between the East and West (see http://www.marketwatch.com/story/asia-millionaires-outnumber-now-us-peers-2012-06-19). While the Asia Pacific region gained 1.6% and the US lost 1.1%, the US is still a contender when counting assets. The score? Asia has 3.37 million people with investable assets in excess of $1 million while the US has 3.35 million. The overall wealth pool fell to $42 trillion (from the $45 trillion I referenced in my previous posts) and is split as follows:

North America – $11.4 trillion

Asia Pacific – $10.7 trillion

Europe (including Russia) – $10.1 trillion

All others (South America, India, etc) – $9.8 trillion

As all hope for a New World Order fades these are the numbers to keep an eye on as nations create alliances that offer the greatest advantage to them on a go-forward basis.

In a recent Inflation/Deflation debate between Jim Rickards and Harry Dent, Rickards proposed that a one world currency/ one world government is still on the table. He sees the mechanism for this to be the IMF and the currency to be the IMF’s special drawing rights. I hold out little hope for the success of such a plan, even if TPTB are still trying (halfheartedly) to implement it. Here are my reasons:

1) SDRs are unfamiliar. To date they have only been used three times in very limited quantities, most recently for approx $200 billion in 2008.

2) SDRs represent a claim on all member nation assets. As such, successful implementation would require wealthy nations to support profligate nations (and we’ve all seen how successfully this is going over in Europe!)

3) The IMF has had little success raising core capital. At the G-20, the IMF announced that it had successfully raised $456 billion (with a measly and hardly ratable commitment of $43 billion coming from China) http://www.marketwatch.com/story/germany-to-allow-europe-funds-to-buy-debt-reports-2012-06-19-1410372

4) While the IMF could take this core capital and use fractional reserve banking to lever it up, it is difficult to imagine China and Russia agreeing to participate in such a scheme when push comes to shove, no matter what noises they make in order to get along right now.

5) As Chris Duane so astutely pointed out in his most recent interview with Kerry Lutz, national memory is long and strong. Just as Europe remembers WW2 and Germany is leary of any alliance with Russia because Russia still remembers WW2, too, Michael Cembalest in his most recent Eye on the Market states:

‘Any discussion of China’s engagement with the world needs to factor in China’s troubled relations with the West during
the 19th century. Kissinger (Cembalest had dinner with H.K.) spoke about the impact this era continues to have on China’s political consciousness, which you can grasp by looking at some data and charts: opium imported into China which addicted up to 25% of its adult population, the exodus of Chinese silver to England and India to pay for it, and the collapse in China’s trade surplus. The Chinese Imperial
Commissioner sent a letter to Queen Victoria asking her to cease the opium trade, which was banned in China in 1729 and again
in 1836. Britain ignored the request. After a Chinese blockade of opium ships, the British invaded in 1840, and easily defeated
the Chinese. China was forced to sign the Treaty of Nanking, one of the more one-sided treaties in history. The opium trade then
doubled, leading to another war (and Chinese defeat) 20 years later. The Opium Wars played a large part in the collapse of the
Qing Dynasty and subsequent occupation by foreign powers. This is not seen as ancient history in China.’

What does this mean for you?

Today the Fed extended Operation Twist, which as I pointed out in a post I wrote two days ago, is a sanitized operation, meaning they sell bonds they have that are short-dated and buy bonds they want that are long-dated. Because this results in no balance sheet expansion, it is not inflationary. For this reason, PMs as measured by the market may go down as recession hits. Likewise, many people in Europe and even in the United States will get flushed out of their metals (as austerity hits Europe and those persons unemployed for more than 99 weeks in the US sell anything they can lay their hands on simply to eat). Additionally, market traders may pile in to drive prices down so they can pick them up cheaper. (When I speak of people being flushed out of metals, it is these people of whom I speak, not readers of DTOM who know better!!!)

As recession hits, if assets get cheaper this is simply a huge buying opportunity.

How low could metals go and should you wait? Chris says “I’d rather be seven years too early than one year too late.” and I agree. The election in November, the need to increase the debt limit again this fall, and the fiscal cliff are all reasons to be buying while others are selling. Dollar cost average in if you like, but don’t go into 2013 sitting on piles and piles of cash. There is a reason why major changes happen immediately after an election cycle…it is easier to get stuff done when the pesky electorate is powerless to stop you (ex. Obamacare)

I welcome all questions and comments. In keeping with the memory of Bob Chapman…I answer every one.

The Multi-generational Household – Coming to a House Near You

Dana Meador — Tue, 19 Jun 2012 09:14:40 +0000

First a little history. One of the reasons WW2 fueled such a boom in America was that while the men were at war (and earning GI pay), women were at home (earning labor pay). Since everything was being rationed, there weren’t a whole lot of Michael Kors handbags being sold, and so the money these duel income families had saved was able to be used after the war to fuel investment – primarily in housing – and America was soon off to the races again. The men worked, the women mostly stayed home, but there was full employment and America was able to grow its way out of its war debts. When the US debt to GDP ratio once again got out of control in the seventies and inflation began to bite, the solution households themselves implemented turned out to be the thing that made the most difference – namely that women went to work. The cure for the seventies was not just Reaganomics, it was sharing the bite of inflation between two workers in most households.

As we experience seventies-style inflation, once again households themselves are making the most important adjustment of all. As we see savings, retirement accounts, pensions, social security, and Medicare lose purchasing power and unemployment biting the oldest, youngest, and minorities the worst (while the rich get richer), we are in the midst of a change in the number of people opting to live under one roof to make ends meet. For this reason, I don’t expect real estate to recover meaningfully. Just as commercial real estate has suffered from the rise of online shopping, residential real estate will suffer from the coming multi-generational housing paradigm.

That this paradigm is the norm in most of the rest of the world will not be lost on many of us. Which makes me ponder the question, when the US exports its inflation to the rest of the world, as it did in QE2, what are people in China, India, Africa and Russia going to do (other than despise America, of course)?

The Truth About Twist

Dana Meador — Mon, 18 Jun 2012 13:53:13 +0000

When next the Fed meets on June 19 and 20 of this week, one of the items on the agenda will be the continuation and/or expansion of their “twist” program. So what is twist, and why are they doing it? Twist is a program by which the Fed buys long dated treasuries and sells short dated treasuries. If they buy from the open market and sell from their current holdings, twist is, on the face of it, balance sheet neutral (meaning the Fed is not increasing its balance sheet to do it) and therefore not additionally inflationary. It is what is commonly referred to as a “sanitized”operation. The publicly stated purpose for engaging in operation twist is to affect interest rate reductions, particularly in the ten year treasury rate (from which all mortgage interest rates are derived). This is critical to a recovery in housing as low interest rates, particularly when ARMs are involved, allow housing to be more affordable.

The other benefit, not talked about in the media, is that Project Twist, when combined with additional treasury purchases results in the Fed owning the long dated maturities and the foreigners and the public owning the short dated treasuries, which is exactly what you want when you are getting ready to rapidly inflate away your debt.

The Great Asset Grab is Almost Over

Dana Meador — Sat, 16 Jun 2012 16:16:59 +0000

I have spoken before about the $210 trillion in paper money circling the $45 trillion in worldwide investable assets (PMs, real estate, equities). The situation is much like the scene from the movie Far and Away, which depicted the Oklahoma Land Rush of 1893, where thousands of people lined up to race against each other to get a piece of land for free. Then, as now, the unscrupulous found a way to beat out their competition, thus earning the nickname “Sooners”.

Where are we in the Great Asset Grab of 2008-2012 and who owns anything that matters? If you haven’t had a chance to listen to Michael Hudson speak on the subject of neo-feudalism, you should. It is the key to discerning the goal, the end game, of what is happening to the world’s economy. (See Hudson’s interview with Max Keiser here: http://youtu.be/RD3O8OJuKWk) Many people have it wrong. They are too far down on their own level and fail to see the forest for the trees. The real economic war currently being waged is not about the 1% vs the 99%. It is about concentrating asset holdings and forming alliances, West vs East. It’s about who gets stiffed for the bill of the West’s profligacy for the past 40 years and whether the West can hold onto enough assets to reconstitute itself powerfully enough to remain a force to be reckoned with after the global currency reset.

The fact the China has abandoned all patience in its recent purchases of physical gold (http://www.zerohedge.com/news/hoarding-continues-china-purchases-record-100-tons-gold-april-hong-kong), that they are purchasing not only hard assets but also miners geographically situated in the Eastern hemisphere (http://www.zerohedge.com/news/are-chinese-buying-dips-gold), that they are buying farmland in New Zealand (http://www.aljazeera.com/video/asia-pacific/2012/04/2012420141723456740.html), that they creating trade alliances that don’t require USD to settle, even with JAPAN (http://news.in.msn.com/exclusives/it/article.aspx?cp-documentid=250160300) all stand as proof of intention and the rapidity with which events are unfolding.

Likewise, in Europe, on Thursday we saw Germany tip its hand. Simon Hobbs of CNBC reported that the structure of any new bailout packages for Spain and Italy will include a pledge of their gold reserves as security for the 25 year loans. Greece has sold or pledged all of its productive assets, not to get more money to assuage the plight of its people, but simply to make the most recent payment due to its loan sharks.

Yes, I understand that the main thrust of this site is about buying physical silver and forgetting about the rest. But it is important to understand that the real game isn’t even about us, the small fry. In all likelihood most of us will get flushed out of whatever silver we do have long before we can actually use it to invest with once the new paradigm comes into play. The real game is not about us. It’s about aligning massive amounts of real, investable wealth, East vs West, until all there is no more real wealth to be gotten at any fiat price, even by hook and by crook.

There is no country on earth where the poor (those who live paycheck to paycheck and have no savings) are not mere pawns in this grand global chess game. The poor aren’t even direct serfs, they are merely the serfs of serfs and as such are completely irrelevant. But now the middle class is rapidly also being diminished to pawn status. There is just one event left to secure global neo-feudalism and that is….drumroll please….letting the system collapse.

Dollars to donuts, your parents and grandparents are afraid of holding any real asset whatsoever (other than maybe their house). They have heard the term “return OF capital, not return ON capital” so many times that they now sit on piles and piles of bonds. “But I have cash in the bank!” they say. Guess again. What do you think the banks have done with all that idle cash? They’ve been buying bonds and lending it to themselves and their friends to buy real investable assets, that’s what.

I don’t normally like to predict timing events but I must say I see little point left in delaying this game past the election in November. Whatever title the banks needed to perfect (and could) in the aftermath of the 2008 debacle has been perfected though low interest rate refinancings. There is no significant wealth left to grab. All that is left is the final chapter in the game, the one in which the paper wealth of the elder middle class evaporates as a casualty of the move in which the knights, rooks, and bishops take the board and inflate away China’s FX holdings which form the backbone of its economic might.

ECB LTRO is Wreaking Havoc With the Markets

Dana Meador — Sat, 28 Apr 2012 14:26:52 +0000

I have to admit that when the ECB unleashed over $1 trillion of cash in exchange for trash in December and February I fully expected gold and silver to go up as the money migrated to hard assets. Over 500 banks in Europe were given just three years in which to double the money they were lent and use it to redeem their junk from the ECB without having it kill their balance sheets. And initially gold and silver did go up. But then an odd phenomenon happened. The banks’ proprietary trading desks realized they can make even more money creating and trading volatility in the US stock market. Short the high flyers and go long the financials that have been handed this massive lifeline…what could be easier? Who knew the high flyers could go higher? Who knew all the shorts would have to cover when earnings came in better than expected? Which is why we are seeing the most desperate, insane earnings season it has ever been my displeasure to witness. Amazon and Expedia were up 14% and 25% respectively yesterday on earnings beats that historically would have moved their shares less than 5%. Sandisk missed and got taken to the woodshed for an initial 25% decline (now recovering, of course). You think retail investors will come back to this? Snort.

In the final scene of the movie Too Big To Fail, Bernanke and Paulson infamously ponder the effects of loaning the banks $700 billion in TARP funds with the expectation they will use it to stimulate the economy. “They will loan this out, won’t they? Won’t they?” You have your answer, Central Banksters of the world. They won’t. Nor will they use it to save Spain, Italy, or even France. Why lend Spain and Italy money at a measly 5% per annum with no possibility of principal repayment when you can make 10 times that day trading the most liquid market in the world? The Fed and ECB need a new song, cuz providing the banks with liquidity is only creating greater income disparity and more market dysfunction.

Don’t Count The Miners Out Just Yet

Dana Meador — Thu, 26 Apr 2012 14:03:25 +0000

Yes, labor and energy costs are going up. Yes, geo-political risk is a problem. Argentina is nationalizing…who’s next? But there are also some good things happening for some of the miners, especially the ones with geographic diversification and a strong balance sheet. I am seeing miners taking advantage of low interest rates to lock in 3-4% long-term financing. Shaving off huge interest costs can do a lot to help defray the cost of higher energy and labor (which is still cheap no matter how you slice it). And miners are seeing the costs of developing new projects escalating prohibitively, which makes miners who had the foresight to develop their plays in 2008-2010 all that more valuable. Gold and silver miners are fortunate because even when inflation bites on the expense side of the equation, revenues more than make up for it. I also think miners are wising up and holding back delivering inventory when the price is not to their liking. Miners have gone from hedging the price of gold, to not hedging, to actually holding gold on their balance sheet as an investment. What better endorsement of the commodity can you get!

Newmont (8.5 forward PE) announces earnings tomorrow and Barrick (6.5 forward PE) on May 2. If I’m right saying that the analysts have been overly harsh on this sector, be prepared for a hot time in mining shares as we head into the coming debt ceiling debate and election fiasco season.

Fed slap-down or brilliant Idea – What do you think?

Dana Meador — Thu, 26 Apr 2012 13:38:15 +0000

On April 13, Sheila Bair (aka, the woman who just stepped down as head of the FDIC) wrote an op ed in the Washington Post entitled Fix Income Inequality With $10 Million Loans for Everyone! (see link below) Perhaps she is just suffering from PTSD resulting from having to manage bank failures with only $18 million in capital and a $200 billion backstop line of credit from the Treasury, or maybe the gal’s onto something…what do you think? (I suspect that in terms of percentages there are as many shadow bank failures waiting in the wings as there are shadow homes waiting to be foreclosed upon)

http://www.washingtonpost.com/opinions/fix-income-inequality-with-10-million-loans-for-everyone/2012/04/13/gIQATUQAFT_story.html

P. S. If you think that’s bad, SIPC only has $100 billion in net assets and has NO GOVERNMENT GUARANTEE. Most people don’t know that when you execute a sell trade in your brokerage account it takes three days to clear to cash. During that time frame (and afterwards if you have not specifically designated that the cash held in your brokerage account be held in an FDIC insured account), you are vulnerable in a way that only MF Global customers can truly understand.

What Are The Options?

Dana Meador — Sat, 21 Apr 2012 17:48:19 +0000

1) Growth. Growth is not an option. Most economists acknowledge that we would need to grow at a rate of 20+% annually to grow our way out of our problems. This is impossible in a mature economy burdened with an aging populace and a combined “true” public and private debt in excess of 600% of GDP.

2) Austerity. Austerity is not an option. Direct federal government expenditures make up 23% of GDP. Include the indirect (multiplier) effect of government spending that is re-spent into the economy and you are looking at a government-related GDP contribution of 35%. To balance the budget, the government would have to spend half of what it currently spends – a direct hit to GDP of 10+%, with an indirect effect of 15% (worse than the Great Depression). To actually amortize the existing debt would take much more. And this is just analyzing the “on balance sheet” debt of the federal government.

3) Direct default. Direct default is a very bad option. Our national debt is held primarily by federal and state “intergovernmental agencies” (60%) , foreign central banks (30%), and banks and other investors (10%). What would happen to each in the even of default?

1) Central Bank bankruptcy (no loss there)

2) Social Security and Medicare bankruptcy (social backlash)

3) Probable retaliatory write-offs of all foreign obligations owed to the US and expropriation of all public and private US assets on foreign soil (triggering additional protectionist sentiment if not outright war)

4) Federalization of banking institutions holding sovereign debt assets (both domestic and foreign) in excess of tangible common equity (virtually all banks)

5) Loss of pension and investor capital through outright government default, expropriation of foreign assets, and decline in the value of assets triggered by the ensuing financial depression/chaos (more social backlash)

(Additionally, since the US would no longer be a credible borrower, post-bankruptcy the US would have to balance its budget and re-institute sound money backed by some form of universally recognized (and portable) collateral. Additionally, the government would need to effectively end all social programs because it would need to keep spending on defense in order to deal with heightened external threats and internal social unrest.)

4) Printing money. Printing money is also a bad option but a better option than outright default. Since foreign countries, banks, and investors always had the option of trading treasuries for dollars, they recognize they have nobody to blame but themselves for making a poor choice of investment. Printing money starts out fairly benign and ends up in social unrest when the Ponzi scheme ends with the Central Bank buying up all the remaining treasuries (thereby releasing a flood of dollars into the economy virtually overnight). Anti-US sentiment arises from inflation caused by the role of the dollar as the world’s “reserve” currency, but you don’t see obvious financial retaliation beyond a dumping of US treasuries. What you do see is social upheaval as that flood of dollars works to find its way into non-financial assets.